Bears should tighten their stranglehold on Indian shares as more doubts emerge about the country's economic growth, while the corruption-scarred fractious ruling coalition gives no hope for breaking the impasse in policymaking.
Corporate earnings are falling as consumer spending took a hit from sharp increases in interest rates, and many companies that have borrowed abroad to fund acquisitions or expansions are facing a heavy burden due to the rupee's slump.
Investments by companies have ground to a halt highlighting the lack of business confidence. Large projects such as the mega power plants which cost billions of dollars to build are staring at a big stumbling block due to lack of coal to feed them.
"Gridlock in policymaking is taking a huge toll on the economy and this is being reflected on the stock market," said a fund manager at a foreign financial institution, who has cut his exposure in Indian shares.
"Everyone knows growth has slowed sharply this year, but the bigger worry India faces is the year ahead could be worse," he said.
Foreign funds outflow
Foreign funds are net sellers of about $500 million (Dh1.836 billion) of Indian stocks this year, a sharp contrast to record net purchases of $29.4 billion in 2010, and this has driven the Sensex to 15,738.70, down 23 per cent since the close of last year.
Christopher Wood, a top strategist at brokerage CLSA, said the Sensex could tumble to 11,000-12,000 if the Eurozone debt crisis imploded and triggered a sell-off. "What is increasingly worrying from a more narrow market perspective is the potential for a reflexive vicious cycle in Indian assets, be it currency, bonds and equities, where negative news builds on itself," he said in a note that downgraded India to "neutral" from "overweight".
"The key risk here is the currency, given the central bank's failure to defend the exchange rate more proactively, given the current global context of acute risk aversion, and given the existing large dollar borrowing by Indian corporates."
CLSA last week slashed its forecast for India's economy growth to 6.7 per cent for 2011-12 from its earlier estimate of 7.3 per cent, saying the government's inability to take policy decisions, high borrowing costs and coalition politics have scared away investors.
"These domestic factors have added to the adverse impact of global headwinds, and have taken a bigger toll on growth," Rajeev Malik, an economist at CLSA, said in a note. Singapore-based Malik said the rupee could tumble to 58 against the US dollar in 2012.
"The RBI's recent measures to check speculation in the currency market and to boost capital inflows will help the rupee but a strong dollar rebound could easily cause Asian currencies, including the rupee, to depreciate significantly," he wrote.
The RBI swung into action after the rupee plunged to a record low of 54.30. Although the rupee has pulled back to around 52.96, the currency has fallen for three weeks in a row and the outlook is bearish.
"As always, the rupee will suffer more as India runs a current account deficit compared to surpluses by other economies," Malik said.