IBN Icici Bank Ltd

MUMBAI—A wave of foreign money is helping put Indian stocks among the world's best performing this year, with investors confident the market can withstand any reversal of this year's global rush into emerging-market equities.

The benchmark S&P BSE Sensex is up 8.3% so far this year, and is now less than 5% below its all-time closing high set in January 2015. Among major emerging markets, Brazilian and Russian stocks have performed better—but both are rebounding from three years of losses.

The fever for Indian stocks is evident from the country's booming initial public offerings. Last week's $900 million float of ICICI Prudential Life Insurance Co., an Indian insurance company, was the country's largest in six years—yet it was oversubscribed by 10 times.

Overseas investors have caught the bug: Around $7 billion of foreign money has flowed into the Indian market this year, up from $4 billion over the same period in 2015, according to regulatory data.

That could leave India vulnerable if the "global search for yield" goes into reverse, the trend by which investors have scoured the world for higher returns. Some fear any future series of rate increases by the U.S. Federal Reserve could trigger such a reversal. On Monday, the Sensex fell 1.3%, in line with other Asian markets.

But investors and analysts say India—where annual growth reached 7.5% in the first half of 2016, beating China's 6.7% expansion—could eventually prove better placed than other emerging markets if global capital flows turn. They cite factors including government reforms under Prime Minister Narendra Modi as reasons to remain optimistic.

"India is in a Goldilocks situation," which is attracting global investors, said Sumit Jalan, co-head of investment banking at Credit Suisse in India. "Foreign investors are driving [Indian] markets."

Once lumped in with a block of emerging markets termed the BRIC—Brazil, Russia, India and China—India has lately diverged from the group, in part thanks to its heavy weighting toward domestic consumption. By contrast, Brazil and Russia have been hit by the slump in global commodity prices, while China's exports have suffered from a slowdown in world trade.

Over the past three years, Indian shares have gained a cumulative 44%, beating the 37.5% rise in China's Shanghai Composite, and well ahead of the 8% rise in Brazilian shares and the 31% drop in Russia.

India's inflation has eased, its trade deficit has narrowed thanks to lower oil prices, and the rupee has been relatively stable against the U.S. dollar this year. Recent good monsoon rains could help boost agricultural productivity, and thus consumer demand from rural India.

India's government has delivered on some planned reforms: Parliament this year approved a long-pending bill to replace myriad federal and state taxes with a national goods-and-services tax. It also cleared a new bankruptcy law which could make it easier to wind up a failing business.

Some reckon investors will continue to differentiate India from other leading emerging markets, in the belief that Indian consumers would keep buying new cars, televisions and mobile phones. Shares of consumer-goods companies, auto makers, banks, and cement companies have risen sharply this year, with some gaining as much as 60% in recent months.

"They're all very clear: India is the stable part of my portfolio, I keep it. The rest I'm trading around," said Bharat Iyer, head of equity research at J.P. Morgan in India.

"Things look aligned for a fairly sustainable cycle for India going forward," said Matthew Dreith, a fund manager at U.S. money-management firm Wasatch Advisors, which has $6.8 billion invested in emerging markets. Its allocation to India has increased to $1.2 billion over the past two years.

With a market capitalization of more than $1.6 trillion each, India's main stock exchanges—BSE Ltd. and the National Stock Exchange—now rank 10th and 11th in the world, respectively, according to the World Federation of Exchanges. Only around half of the listed stocks is available for purchase by investors, since company founders often hold the majority of their shares. Foreign investors own around one-quarter of all shares issued by India's top 200 companies.

One concern is that Indian stocks have become overvalued. The Sensex currently trades at around 18.5 expected company earnings for the year ending March 2017, above its 15.5 times long-run average forward price-to-earnings ratio, according to local brokerage Sharekhan Ltd.

Still, analysts believe that higher profits will justify the high valuations. J.P. Morgan said it expects profits for companies in the benchmark Nifty 50 index to rise by 8% to 10% for the financial year ending March 31, 2017, and by 15% in 2018.

Indian companies are capitalizing on investor demand by launching a flurry of new equity issuance. While IPO issuance has fallen this year globally, total deal values in India have nearly tripled to $2.8 billion, according to Dealogic. Bankers say other large flotations in the coming year include those for the Indian unit of U.K. mobile-phone company Vodafone Group PLC, and India's largest securities exchange, the National Stock Exchange of India Ltd.

Write to Shefali Anand at shefali.anand@wsj.com and Debiprasad Nayak at debi.nayak@wsj.com

(END) Dow Jones Newswires

September 26, 2016 08:35 ET (12:35 GMT)

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