The ominous signs for Indian equities are making investors uneasy. Foreign funds, the market’s trendsetting investors who own stocks worth about $330 billion (Dh1.2 trillion), were among the sellers this week in a show of frustration at the slow pace of government reforms, sluggish corporate earnings and the lack of confidence among businesses to invest in new projects.

A steep increase in fuel costs — petrol prices were raised by nearly Rs4 a litre and diesel by Rs2.4 — effective May 1, when the markets were closed for a holiday, would likely further undermine investor sentiment as the move would pile pressure on inflation and hit a host of industries. Oil refiners, however, should get a leg up.

The top-30 Sensex, which posted a second consecutive monthly drop in April, has lost 10 per cent since hitting a record 30,024.74 in early March. The benchmark that is widely tracked by fund managers fell to 27,011.31, its lowest close in nearly four months and wiping out gains in 2015.

The broader 50-share Nifty has plummeted 10.3 per cent from its all-time high of 9,119.20 struck on March 4 as the index also fell for the second successive month, ending at 8,181.50 in April and down 1.2 per cent in 2015.

Having dropped below support levels, both the indices could shed more ground before regrouping for a pullback. Widespread damage to crops from bad weather and suicides by debt-ridden farmers have put the government on the back-foot, and political opposition to easier norms to acquire land look set to unravel a key reform needed to revive investment.

Lingering worries over back-tax demands on foreign investors continue to weigh on the market. Although the government has said that funds under existing tax treaties may be excluded, more than half of the investors might still be liable to pay taxes, according to DBS Bank.

“In addition, with much of the positivity already baked into the asset markets, focus is on growth and reform deliverables, which are yet to catch-up with euphoric expectations. This might hurt the extent of incremental foreign inflows which might be channelled to the Indian markets in the coming months,” said Radhika Rao, economist at the Singapore-based bank.

Apart from worries over the pace of recovery, the rebound in crude prices and likelihood of a weak monsoon has also raised doubts over the inflation outlook, she said. “We look for the real economy to recover gradually, with the rebased growth rate at 7.8 per cent this year from 7.4 per cent in 2014/15.”

Silver lining

Amid the gloom, however, there is hope. The big drop in share values could make the market attractive to newer investors who are looking for better growth opportunities than elsewhere. For all the problems that hobble India and chip away at the potential, the country is still expanding at the fastest clip for a major economy.

“Post the recent correction, risk-reward for the market has improved. Our December-2015 Nifty target of 9,200 is based on 17 times one-year forward PE. This target implies a reasonable risk-reward given risk-free rate in India of 7.8 per cent,” UBS equity strategists Gautam Chhaochharia and Sanjena Dadawala said in a report.

They said the critical event ahead would be the minimum support prices (MSP) for farm crops that New Delhi usually announces in June. Big increases by the previous Congress party-led coalition had caused a spike in inflation over 2009-13, and the new administration reined in the situation last year helping bring down inflation.

“Weak rural trends, recent unseasonal rainfall affecting some crops, political capital needed to push land bill and decline in popularity as per surveys has created concerns on potential dilution in this approach,” the analysts wrote.

The Commission for Agricultural Costs and Prices has recommended a 3.7 per cent increase in MSP for paddy or rice. “Any number above 5 per cent may hurt market sentiment, though it may aid some underperforming rural-focused stocks [for example Hero MotoCorp],” they said in the report. “Our base case is that the government will not give in to populism pressures in the short term.”

UltraTech Cement, L&T

Despite lower-than-expected earnings growth for many companies, and reductions in profit rise estimates by brokerages, there are a few trends that are worth noting.

In cement, for instance, producers like UltraTech are able to raise prices in a tough market, helping the company to meet market expectations.

“While demand growth being subdued is a concern, the return of some marginal pricing power (realisations up 8 per cent year-on-year on freight adjusted basis) after a gap of nearly 18 months and the benign cost inflation is comforting,” analysts Chockalingam Narayanan and Manish Saxena at Deutsche Equities said in a report.

“With company also opportunistically adding capacities — both organic and inorganic around replacement cost, we remain constructive. Post a 20 per cent fall in the stock price since March (13 per cent below the wider market BSE Sensex), the valuations have corrected to enterprise value per tonne of $175 (marginal premium to replacement cost of a greenfield unit) and hence we retain buy.”

Shree Cement and UltraTech were the preferred picks in the sector, the brokerage said.

Larsen & Toubro Ltd, the country’s biggest engineering and construction conglomerate, could ride a potential jump in orders as the government pushes ahead with its “make-in-India” campaign, particularly for sectors such as railways and defence.

Domestic manufacturing for defence

New Delhi aims to spend the equivalent of $137 billion over 2015-20, a sharp rise from $37 billion over 2010-14. “About 50 per cent of the capex is on construction works, which provides significant opportunities for L&T,” Girish Nair at BNP Paribas said in a report.

“L&T has been shortlisted as one of the companies to build six submarines worth Rs300 billion over seven years and Battlefield Management Systems worth Rs400 billion over eight years. These could lead to orders that would create Rs36 billion per annum of incremental sales. More orders could come as the government encourages domestic manufacturing for defence.”

“We rate L&T as the top pick in our cap goods coverage universe as we believe it will be the biggest beneficiary of an improvement in the investment cycle (which we expect in second half of 2015-16) due to its exposure to all major end markets such as power, railways, defence, construction, real estate, industrial automation and oil & gas,” Nair said.

“The scarcity of alternative plays also puts L&T in a sweet spot. While there are margin concerns from international orders that pose downside risk to near-term earnings, a pickup in domestic orders and corresponding execution should materially offset the negative impact over the long run.”

The brokerage raised its target price of the stock by 15 per cent to Rs2,060.

The writer is a journalist based in India