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The Indian stock market reached a record high recently and remains buoyant. We take a look at the rising amount of foreign investment coming into the country and look at some of the reasons why

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Many analysts have attributed the current buoyancy of the Indian stock market – called the Sensex – to the fact that foreign institutional investors (FIIs) have invested a whopping £3bn into Indian stocks over a period of just several months.

The trigger for this substantial investment into India came after the US Federal Reserve delayed the tapering of its monetary stimulus last September.

A heavy foreign fund inflow into Indian blue chips such as Maruti Suzuki, Bajaj Auto and Tech Mahindra quickly followed.

But following this investment, a number of observers suggested the new highs had been driven by only a handful of expensive stocks and that the danger was that this surge could be short lived.

Despite the record highs, the Sensex was Asia's fourth-worst performer in 2013 in dollar terms, with an overall fall of 2.6%. The returns have been hurt by a weak rupee, which hit record lows in August that sparked concerns about a currency crisis in the country.

As a direct result of the currency situation, foreign investors have actually earned a negative return from the Sensex, while domestic investment in the equity market has remained low.

What is required is an improvement to the fundamentals to encourage the new liquidity to remain and increase.

Stalled reforms

Much-needed economic reforms have pretty much stalled due to bickering among political parties and it is true that corporate earnings have been average or even lower than in 2012.

Unclear rules governing foreign participation and political opposition have also proved to be a barrier to entry for many.

However, since taking office in September 2013, Raghuram Rajan, the governor of India’s central bank, has called for financial-sector liberalisation as a way to boost growth and help the poor.

He has argued that the current national financial system, a mixture of nationalised banks, financial socialism and the product of reforms from the early 1990s, needs to open up.

Conversely however, a weak rupee has proved tempting for foreign investors bringing money to India, while large stable Western companies have plenty of cash on their balance sheets but little option to invest in the economies of Europe and the US. The opportunity to invest in a country with 1.2 billion consumers is also a massive incentive.

The biggest destinations of foreign money have been the services industry, telecommunications, computer software and hardware, as well as construction and real estate.

In real terms, this means that foreign firms would have no problem buying out the ownership of an airport, a cash-and-carry or wholesale trading operation, a scientific or technical publishing house, a mining or oil exploration operation or industrial park.

India has, however, been very careful to limit access to areas of the economy where there are concerns in relation to either national security or where there might be a serious social impact.

As a result, there is a currently a ban on foreign firms buying into businesses such as lottery firms, atomic energy producers or manufacturers of cigars, cheroots, cigarillos or cigarettes.

Recent foreign investment has included British pharma giant GlaxoSmithKline, which has spent £600m to raise its stake in its Indian arm, GSK Pharmaceticals, from 50% to 75%.

Unilever invested £2bn on stocks of Indian arm Hindustan Unilever in July 2013. The followin month, McGraw Hill, the owner of global rating agency Standard & Poor's, increased its stake in Crisil, the leading Indian rating agency.

Meanwhile, Britain's Tesco is also set to become the first foreign supermarket to venture into India's £300bn retail sector after announcing in December 2013 it had applied to buy a 50% stake in Tata Group's Trent Hypermarket.

The world's third-largest retailer has made an application to India's Foreign Investment Promotion Board and plans to invest £70m.

Companies with cash and businesses to grow are putting their money where they see growth – that place includes India. That growth is likely to get stronger over the next few quarters.

There are firm grounds to believe that observers who had foreseen the end of India's growth story may now be rethinking their predictions, amid the rising tide of investment inflows that these deals represent.

If the government increases investments in infrastructure and simplifies its framework, growth could return in dramatic fashion.

Last updated: 6 Feb 2014