Foreign investors are putting more money into India as they seek to profit from its relatively high bond yields and pare exposure to SARS-hit Southeast Asia.
Indian bonds have always offered attractive yields compared to more developed countries, but exchange rate losses caused by a depreciating rupee had discouraged foreign funds.
Now the tide has turned. The rupee appreciated against the dollar in 2002 for the first time in more than a decade, by 0.55 per cent. It has gained about 1.5 per cent this year and is set to climb more, traders say.
"The arbitrage between domestic and global interest rates has always been a factor," said Sashi Krishnan, chief investment officer at Cholamandalam Asset Management. "The added comfort now is the rising rupee. So long as the unit maintains this trend, we expect flows to continue."
Foreign funds have more than $16 billion invested in India, mostly in stocks. But for now bonds are drawing more new funds.
The latest data shows overseas funds pumped $63.9 million into bonds during May 2-8, after $97.1 million in all of April and $130 million in March. That is a huge jump from the $3.9 million invested by the funds in bonds during the whole of 2002.
Ten-year Indian bonds yield around 5.9 per cent, against 3.6 per cent for comparable US Treasuries. As of Friday, the JP Morgan India Government Bond Index, which measures overall returns from bond investments, had risen 3.3 per cent in 2003.
The rupee's rise has boosted that return for investors who measure their performance in dollars, and the currency is expected to firm further.
A Reuters poll on Friday forecast the rupee to rise to 46.98 per dollar by the end of September from Rs 47.18 last week.
Bank stocks among top picks
Foreign funds are still putting fresh money into Indian stocks, even though they have been among the world's worst performing this year. The key Bombay share index is down 12.7 per cent this year.
Foreigners bought $50.3 million of stocks this month, down from $115.1 million in April, which was the highest since January.
The inflows have been helped by money shifting out of Hong Kong, China and Singapore, whose economies have been hit by Severe Acute Respiratory Syndrome.
Data compiled by Lipper, a Reuters company, showed the value of stocks held by the regions' 20 biggest institutional investors fell in April in countries affected by SARS.
Hong Kong dropped 2.11 per cent, Singapore fell 1.65 per cent and China declined by 2.02 per cent over the previous month while India gained 1.75 per cent.
"SARS would have hurt the short-term sentiment, leading to some outflow from the affected countries," said Hemant Kulkarni, who is based in Bahrain and manages about $40 million for TAIB Bank.
Banks, riding a boom in retail loans growth and bond trading profits, are among the top picks for foreign stock investors. Fund managers are also betting an industrial recovery would feed into domestic-focused sectors like automobiles and steel.
"The growth in retail loans continue to be a strong earnings driver for the sector," said Ashish Goyal, who is based in Singapore and helps manage $6 billion in Asia for Prudential Asset Management.
Shares in state-run banks, which dominate the industry with around three quarters of total deposits, trade at forward price-earnings multiples of five to six, making them cheap buys. That compares with a P/E of about 10 for the key share index.
Inflows would pick up steam, fund managers say, if plans to privatise refiner Hindustan Petroleum Corporation go well.
"HPCL's success will lift India's profile," said Singapore-based Samir Arora, head of Asian emerging markets at Alliance Capital Management, with about $350 million invested in Indian stocks.