Darkest before dawn: Why some foreign investors are buying India By Subhadip Sircar and Suvashree Dey Choudhury MUMBAI (Reuters) - Newspaper headlines spew doom and gloom about India. Analysts are topping each other with ever-more-dire pronouncements on the country's prospects. And yet some foreign investors are not only ignoring the warnings, they are buying more shares. It flies in the face of conventional wisdom to bet on a country with a currency tumbling to record lows and a government that is clutching at straws to deal with India's worst economic turmoil since its balance of payment crisis in 1991. Yet to some financial firms such as Ashmore Group in London the panic gripping India ignores an economy that, although slowing sharply, is far from collapse. So much hand-wringing over the state of the economy today masks the long-term compelling play that attracted many foreign investors to India in the first place, including a young, urbanizing population that will drive consumer demand and an economy that is increasingly diversifying into exports. "The market is obviously currently gripped in a sense of panic and, as such, it is not paying a lot of attention to the underlying fundamentals," said Jan Dehn, head of research at Ashmore Group in London, which manages $80 billion worldwide. What happens in these situations is that where the market has gone and what actually exists on the ground in reality have parted ways with each other. The case against India is not hard to make. Investment has melted away and data is pointing to a plunge in manufacturing and service-sector output. At the same time, the current account deficit is at a record high, a stubborn fiscal deficit has raised the risk of sovereign rating downgrades, and the central bank's recent cash-draining steps threaten to raise borrowing costs across the economy. Some analysts say India's bond market is pointing to the risk of recession. Banks from HSBC to Goldman Sachs have cut their economic growth forecasts for India in fiscal 2013/14 (April-March) to below the already decade-low of 5 percent in the previous year. Yet some investors believe the pessimism is overdone. Even if growth were to slow below 5 percent, that would still be a faster clip than some other one-time darlings of foreign investors, including South Africa and Brazil, which are both expected to grow at around 2 percent. Analysts also point to growing indications that the rupee has overshot, especially after new Reserve Bank of India (RBI) Governor Raghuram Rajan sparked hopes that recent controversial measures will be unwound. The RBI is also widely expected to return its focus to reviving growth, having put a series of interest rate cuts on hold to defend the rupee. Teera Chanpongsang, a portfolio manager at Fidelity Emerging Asia Fund, still has faith in the prospect for higher growth. I'm still confident GDP growth will come in around 5 percent despite these hurdles. I continue to invest in positions that are long-term winners, such as pharmaceutical companies, IT outsourcing companies and select high-quality banks," she said. Meanwhile, signs are emerging that India's current account deficit could narrow substantially in the current fiscal year from the record high of 4.8 percent of gross domestic product. Exports surged in July, leaving the trade deficit at $12.3 billion, well below the monthly average of $16 billion in 2012-13. The slumping rupee and signs of an improving global economy led by the United States also bode well for shipments overseas. At the same time the rate of imports is expected to slow after a slew of measures from policymakers to curb demand for gold, the country's second-biggest import after oil, including raising duties. Barclays estimates the current account deficit will narrow to $68 billion this fiscal year, lower than the average of $83 billion over the previous two years. Yet the rupee slumped to a record low of 68.85 to the dollar on August 28, for a loss of 20 percent from the end of 2012, falling more than the currencies of Brazil, Russia, Indonesia, or South Africa. While the magnitude of the fall is coloring investors' perceptions about India, analysts say it is more a reflection of years of policy neglect by the government that has left the economy with structural flaws. Maarten-Jan Bakkum, an investment strategist for ING Investment Management's emerging markets fund, believes the ball is in the policymakers' court. "The environment for emerging markets is changing rapidly for the worse and Indian policymakers seem to think they are not part of it, that they can postpone policy changes, without really improving the investment climate or coming up with credible steps to improve the fiscal deficit," he said. I think there are other countries that have more chances of a crisis than India has. The currency depreciation in itself was long overdue. There was clearly a reason for currency depreciation, and it can fall further, but that's not a crisis. The prospect of an end to the Federal Reserve's cheap money has taken its toll on perceptions about India as an attractive destination. However, that is contradicted by remarkably sturdy foreign inflows, despite concerns that high foreign ownership could make the country more vulnerable to selling. Nomura data shows India has received the most foreign equity investments among the emerging Asian countries it tracks for a second consecutive year, totaling around $36 billion, with the prospect of growth and cheap historic valuations cited among the most frequent reasons. Foreign investors who have increased allocations to India this year include the $15.6 billion Templeton Asian Growth Fund managed by Mark Mobius, which had 16.75 percent of its assets in the country at the end of July, up from 15.6 percent at the end of 2012, data from Thomson Reuters Lipper shows. The volatility gives us (a chance) to pay attention and opportunistically buy certain stocks relatively cheap. The quality of these stocks haven't changed over the last six months but their share prices have come off so it's quite attractive for us," said Adrian Lim, a senior investment manager on the Asian equities team of Aberdeen Asset Management. Others such as Emily Whiting, client portfolio manager of emerging markets for JPMorgan Asset Management, believe that over 10-20 year horizon India has better growth potential than China. "As long-term investors looking at the asset class over a five-year-or-more horizon, the fundamental investment case hasn't changed for Indian stocks," she said, citing mortgage provider HDFC Ltd (HDFC.NS) and Asian Paints Ltd (ASPN.NS) as two examples of stocks the fund has added exposure to. Both are about 20 percent below multi-year peaks hit earlier in 2013. Although we recognize that markets could face additional pressure in the short term, we believe adding exposure at current valuations, given the pervasiveness of negative sentiment, will prove profitable for investors thinking longer term. Companies are also willing to bet on India to tap the growth potential of a 1.2 billion population in which 65 percent is below 35 years old. Net foreign direct investment has surged about 74 percent to $6.8 billion in the first three months of the fiscal year that started in April. "We want to invest in the market because we are fully convinced in the long-term growth," said Philipp von Sahr, president of BMW Group India, part of Bayerische Motoren Werke AG (BMWG.DE). The economic situation this year is not so easy, and the exchange rate is not what we want to expect in the car industry. Even then, we will have to invest in the future because in one to two years again it can accelerate fast. Additional reporting by Sujata Rao-Coverley in LONDON, Himank Sharma and Aradhana Aravindan in MUMBAI, and Nishant Kumar in HONG KONG; Writing by Rafael Nam; Editing by John Chalmers and Neil Fullick