The Indian equity market is a favourite among foreign institutional investors (FIIs). For the calendar year till date, Asian markets (excluding Japan, China and Malaysia) received close to $16 billion, of which 53% went into Indian equities. Last year, India received only 29%, when a record $60 billion flowed into the same markets. So in a sense, India benefited this year from higher weightages allocated to it at the expense of other Asian markets?mainly South Korea and Taiwan.

While South Korea received 31% less than last year (till date) in absolute terms, it was a whopping 89% less for Taiwan. Relatively higher dependence on cyclicals?which dances to the tune of health of world economy?has done the damage for these two countries. India, with its strong domestic story and projections of its GDP growing at 8.5% in 2010-11, stood as a safe bet for FIIs.

The big question is whether the FII inflow will continue in the second half?into the Indian markets. Historically, FIIs have always invested more in second half of the calendar year. And in six out of seven occasions, the returns have been more in the second half. So, by that logic, will the second half see net inflows of at least $7 billion into India from FIIs? The gut feeling is no, since this time around higher relative valuations for India vis-?-vis that of its Asian peers is expected to play spoilsport.

One year forward, PE for Sensex is 17.3, while it is 9.8 for South Korean Kospi and 14.3 for China Shanghai SE Composite. Some of these markets are quoting much below their long-term PE averages while India is quoting higher than its long-term average of 16. While one could justify the current high PE ratios to the argument that the future trajectory of Sensex earnings is to happen at a higher gear, the fact is also that the equity market perhaps has already priced it in current share prices. In that sense, Sensex earnings has to catch up with market expectations. Not so the case for other Asian markets.

On the basis of MSCI Asia Pacific (ex-Japan) weights, India ranks fifth, behind Australia, China, Korea and Taiwan and in that order. But the worry is whether the future flows will get diverted to other markets?especially China or South Korea, which are now looking attractive. The simple diversification rule suggests that.

muthukumar.k@expressindia.com