Will India’s surge run out of steam?

Indian stocks have been soaring in recent weeks. But investors may be getting ahead of themselves.

Indian stocks have been on a tear, rising by more than 15% since early September and hitting a new record this week. It's a marked contrast from this summer, when its currency and equities tanked.

One reason investors have returned is that the new central bank governor, Raghuram Rajan, has proved a safe pair of hands, attempting to squeeze out high inflation by raising interest rates twice.

The current-account deficit has fallen, thanks to higher import duties on gold, so India is now less dependent on foreign capital and its assets are thus less vulnerable to global sentiment.

Meanwhile, the lacklustre growth of the past few years appears to be bottoming out. In the third quarter, year-on-year GDP growth accelerated to 4.8% from the previous quarter's 4.4%.

And investors were cheered by the victory of the opposition, led by the pro-business Narendra Modi, in three state polls.

Yet the market surge seems unlikely to be sustained, says Capital Economics. For starters, growth may have ticked up, but there is a "bumpy recovery" ahead.

The improving global economy and recent slide in the rupee have boosted exports, but the key driver of growth is the domestic economy, and this still looks "shaky" due to the "poor investment environment", with pervasive red tape hampering a series of major projects.

As the government's efforts to rectify this have made little progress, it's no wonder investors are looking forward to the opposition taking over the national government in May. But it will still probably need support from "fickle, regional parties" to govern.

High inflation, moreover, continues to constrain household and corporate budgets. India's long-term prospects may be compelling, but for now, as Capital Economics concludes, markets are getting ahead of themselves.

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