http://www.oregonlive.com/business/oregonian/index.ssf?/base/business/117141455279760.xml&coll=7 India's long bull market may be ready to stumble Investing - The nation's central bank is adjusting its rules to put the brakes on inflation Sunday, February 18, 2007 TIM PARADIS NEW YORK -- The empirical evidence of India's enormous economic expansion in recent years -- in particular the sharp run-up in stocks -- has proven an irresistible draw to some mutual fund investors. But those chasing the siren song should be aware that, as with any developing economy, there could be bruising stumbles. "If you have a car speeding along and it hits a speed bump, the aftershock is going to be that much greater the faster the car goes. India is going to hit some speed bumps as it goes," said Andrew T. Foster, director of research at Matthews International Capital Management LLC, a San Francisco fund manager specializing in Asian investing. The rise in stocks has stirred concerns that valuations have risen beyond where they should be and that the country's central bank will continue to raise interest rates at it tries to tamp down inflation. Advertisement On Tuesday, the country's central bank, the Reserve Bank of India, increased the proportion of deposits that commercial banks must hold in cash by a half percent to 6 percent in order to help slow the economy. "The Indian growth story is continuing to be reaffirmed," said Dhruva Raj Chatterji, a research analyst in Mumbai, India, for fund-tracker Lipper Inc. While growth continues, other forces are building that could throw some cold water on the frenetic pace. "It has been a sustained bull run for the past three years because of which India is one of the most expensive markets in the world. Valuations are kind of the higher side," Chatterji said. He questioned whether the market has overestimated how much Indian companies will continue to earn. Earnings growth has in recent years hovered near the breakneck pace of more than 20 percent. Despite lingering questions, Chatterji noted good growth figures helped the markets turn in a decent performance last month. Funds investing in Indian stocks showed an average return of 2.5 percent in January, beating the Bombay Stock Exchange's 30-share Sensitive Index, or Sensex, which rose 2.2 percent. The funds benefited from the performance of midcap and small-cap stocks, Chatterji noted. 29.2 percent gains Over the longer term, the index has won out. Equity funds registered for sale in India rose 29.2 percent in past 12 months, while the BSE Sensex was up an even larger 42.1 percent. And indexes for large and small-capitalization stocks have recently revealed some investors' are looking to cash in. "Definitely it is going to be a year of profit booking and we have seen that happening in the month of February." Chatterji said the amount of money foreigners invested in the country slowed in January. "Interest rates are on the rise in India. People are thinking about whether foreign fund flow will continue with the same vigor as it has in the past," he said. Advertisement Interest rates Subodh Kumar, chief investment strategist for CIBC World Markets, contends investors should consider interest rates before investing in India. Inflation hit 6.6 percent in late January -- a two-year high. On Jan. 31, the Reserve Bank of India raised the repurchase rate, which is the rate at which it lends to commercial banks, by a quarter point to 7.5 percent. "I think that the markets here in India realized kind of late that the central bank is looking at inflation and is still prepared to raise interest rates," Kumar said. "I believe that looking at mutual funds in India the long-term story is intact, but I would wait until it's clear that the central bank has finished raising rates," he said. "A lot of the speculative activity that was in the Indian market is coming out of the market," Kumar said. Still, funds for U.S. investors continue to show growth. The Matthews India Fund, for example, with assets of about $718 million, has shown a year-to-date return of 2.14 percent. Chatterji is concerned stocks in India, and therefore the mutual funds that invest there, could face difficulty later in the year because the number of initial public offerings has increased sharply in the new year. The enthusiasm of investors looking to snag their share of the Indian market risks depleting how much money will be left for investment later, he said. "The number of IPOs has significantly increased. It also poses a danger because that could suck up liquidity in the market. There could be a liquidity squeeze by the end of 2007," he said. However, Chatterji is optimistic that even if a sizable correction occurs, stocks would prove resilient. "Whenever there has been a correction in India there has been tremendous buying support," he said. He credited investors' long-term faith in the potential of the giant and rapidly industrializing country. "But in 2007, it's definitely going to be volatile," he said.