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 India's $4 trillion stock market is pulling in billions of dollars of domestic and foreign money as investors flock to a fast-growing alternative to China, brushing aside risks around overpriced shares, upcoming elections and regulatory uncertainty.

The stream of investment has lifted the benchmark NSE Nifty 50 Index by a third in the last 10 months and attracted $20 billion in foreign inflows in 2023, according to India's national depository data.

India's allure is rising this year as global investors seek substitutes for sickly Chinese markets and as expectations grow that national elections this year will see current Prime Minister Narendra Modi return for a rare third term.

And investors seem happy to overlook risks, such as the already lofty levels the market is priced at and any political surprises.

"The recent rally notwithstanding ... the upcoming elections notwithstanding, I think India is a good market for long term investors," said Vikas Pershad, portfolio manager for Asian equities at M&G Investments.

A steady flow of cash into the stock market from regular retail investment plans, currently averaging $2 billion a month, and buying by domestic institutional investors have been tailwinds.

Goldman Sachs sees the Nifty index, currently around 22,000, hitting 23,500 by the end of 2024, while local brokerage ICICI Securities expects a nearly 14% jump.

The market has become one of the world's most expensive ones. The 12-month forward price-to-earnings ratio, a widely used valuation measure, is 22.8 for the Nifty 50, three times China's and higher even than the U.S. S&P 500 valuation at 20.23, according to LSEG data.

Despite lofty valuations, ICICI Securities expects Nifty earnings to grow at a compounded annual rate of 16.3%.

Global investors' desire to own a piece of the brightest market in the emerging world has been the catalyst, says Remi Olu-Pitan, head of multi-asset growth and income at asset manager Schroders, but that has meant an under-appreciation of the vulnerability and risks.

"Whilst longer term we like India, we completely agree with the growth story, we just worry the market might not be pricing some of the risks that are brewing at the moment," she said.

According to the International Monetary Fund (IMF), India’s GDP is expected to grow by 6.5% in 2024, versus China whose growth estimate is 4.6%.

PERFORMANCE PRESSURE

To be sure, investors are bracing for possible short-term volatility, particularly around the elections, and for the Nifty's rise to be less than linear. As they look to hedge the risk, implied stocks volatility is rising.

The chief risk is the level of expectations.

"It is not India or China, but India and China," says Nilesh Shah, chief executive officer of Mumbai-headquartered Kotak Mutual Fund, referring to how investors now think of the two markets.

"Since India’s premium valuation is on account of other markets not doing that well, now if they start doing well, things could change," he said. And that, he said, meant the market would need to keep delivering better and consistent earnings growth.

While China's efforts to stabilise its economy and markets have yielded little so far, foreigners have been returning to mainland markets this year on hopes of an eventual rebound.

"A large chunk of the country’s appeal right now is that it is not China," said Jeff Weniger, head of equity strategy, WisdomTree Investments.

"In other cycles, we could confidently say that the prospect of these stimulus packages from Beijing would lift all boats, but the risk to India is a bull run in China taking away the intense fear that currently engulfs that stock market."

Stock market regulator the Securities and Exchange Board of India (SEBI) is already cautious.

As domestic institutions, which received inflows of over $22 billon in 2023, burst at the seams, SEBI asked asset managers to stress test their mid and small-cap funds and tightened scrutiny of offshore funds which have concentrated holdings in local stocks.

Domestic ownership of Indian stocks is now at 35.6%, dwarfing the 16% foreign ownership. The remainder is owned by promoters, an Indian markets term for large shareholders who can influence company policy. FACTBOX-How foreign investors can invest in India)

The May election, however, is front and centre on investors' risk maps.

While Modi is hugely popular and his party is expected to maintain its majority in the country's parliament, a weaker than expected result could dampen its ability to push through economic measures that have helped drive markets higher.

“I think the political risk is the highest, so I would call it a low probability, high impact event,” Hemant Mishr, chief investment officer at Singapore-based fund management company S CUBE Capital said.

“If it were to materialise, that would, more than the Middle East crisis, will have a bigger impact on India sentiment.”