Mumbai: The writing on the wall is: Swap Chinese and Indian equities for improving prospects elsewhere, including the US, where stocks look attractively priced even after a rally.

Rising interest rates in China and India, the world's two fastest expanding major economies, are bound to hit demand, cool growth and squeeze corporate earnings. There is little surprise why investors are pulling out from emerging markets and plumbing for better returns in the developed countries.

The $1.3 trillion (Dh4.7 trillion) Indian economy, Asia's third-largest after China and Japan, is facing formidable headwinds.

Although the government and private economists believe growth could be around 8.5 per cent in the 2010-11 financial year, the outlook for the next year that begins on April 1 is downbeat.

The widely tracked top-30 Sensex has dropped about 14 per cent since the end of 2010 — becoming one of the top losers in 2011 from among the major gainers last year. And, there could be more losses coming.

Robert Prior-Wandesforde, the Singapore-based head of India and Southeast Asia economics at Credit Suisse Group, said rising borrowing costs could dent economic growth and undermine investor confidence in India.

Growth disappointment

"India's poor inflationary story is well-known in markets, but most continue to expect GDP growth to remain firm, above 8 per cent," he wrote in a research note. "Growth disappointment could be the next factor to hit market sentiment."

He forecast India's economic growth to slow to 7.7 per cent in 2011-12 from an estimated 8.4 per cent this year. The government last week predicted 2010-11 growth at 8.6 per cent, the fastest pace in three years thanks to a surge in the first two quarters.

A series of political corruption scandals has resulted in the arrests of politicians and corporate honchos, paralysed the functioning of parliament and delayed much awaited reforms such as the opening up of the retail sector. Several large projects have also been held up due to environment issues.

Data released on Friday showed factory output growth in December slumped to 1.6 per cent — the slowest annual pace in 20 months, and slower than a revised 3.62 per cent rise in November.

Manufacturing output, which contributes about 80 per cent of the factory data, rose an annual one per cent. Capital goods — a key component that has greater bearing on the sector's outlook — contracted 13.7 per cent in December, indicating companies were putting off capital intensive investment due to rising costs.

The Sensex fell 1.6 per cent last week to 17,728.61, extending a slide for a third week in a row. The benchmark has lost 13.6 per cent this year, with foreigners pulling out $1.5 billion.

"We do not think that the market offers an attractive risk-reward at current levels in light of the substantial macro headwinds and sub-par earnings cycle," Prabhat Awasthi at Nomura said in a report to clients.

Richard Bernstein, a former Merrill Lynch investment strategist who now oversees $100 million of assets in a private firm that bears his name, said US small-company stocks had the potential to give greater returns than emerging markets.

"The US arguably may be the world's most improved economy," he told a gathering of investment managers and financial advisers in New York last week.

"US small cap growth and value is the greatest growth story in the world."

Funds tracker EPFR Global said equity funds focused on the US, Europe, Global and Japan took in a net $6 billion in the week ended February 9, while emerging markets saw an outflow of $3 billion.

About $120 million was pulled out from Indian equity funds, making it four weeks of net redemptions in a row. China saw $309 million outflow, the seventh in 10 weeks, while Brazil lost $164 million, it said. Emerging-market assets will post single digit returns and underperform developed peers this year as central banks raise interest rates to fight inflation, RBC Capital Markets said.

 

- The writer is a journalist based in India.