The Indian stock market has clearly pulled away from the pack. A look at the global MSCI indices shows that the MSCI India index is up 4.6 per cent in the month to September 21 and 15.4 per cent quarter to date compared with 0.4 per cent for the MSCI Emerging Markets Index for the month to September 21 and 3.7 per cent quarter to date. The table shows the extent of outperformance.

What’s also remarkable is that these gains have happened in spite of most FIIs being underweight on India. Obviously, many of them have missed the party. While the figures show that FIIs have been net buyers to the tune of over Rs 3,000 crore in the cash market, they’ve been net sellers of over Rs 2,000 crore in stock futures.

FIIs have been underweight on India because of several reasons, the main ones being the current account deficit and the high valuations. As far as valuations are concerned, the Indian market continues to be one of the most expensive in the MSCI universe, with a forward price-earnings ratio for 2007 of 16.7. Among the major markets, only Japan with a 2007 PE of 17.1 is more expensive. To illustrate the premium at which it trades, consider that MSCI Emerging Markets Asia trades at an average 2007 PE of 10.3, and the US trades at 14.1. On a price-to-book value basis, the valuations are even higher, with MSCI India trading at 2007 price-to-book of 3.5 compared with 1.8 for the emerging markets index.

In spite of the bets against it, however, the Indian market has soared. And while the consensus certainly is that its performance is going to be muted going forward — JP Morgan has a 2006 year-end target of 11,000 for the Sensex — there are a couple of points that are favourable for the Indian market.

The most important of them is the fall in the price of crude oil. The biggest reason for the current account deficit and, in turn, for a bearish view on the rupee, is the price of oil imports. So apart from the positive impact of lower crude oil prices on the oil marketers, there are also indirect benefits, such as a stronger rupee.

Inflationary pressures too will be reduced, which may lead to a pause in raising interest rates. With the US Fed putting interest rates on hold, the odds for the RBI keeping rates steady at next month’s credit policy review have increased, as evident from the sharp fall in bond yields. This will mean that debt-fuelled consumption, which has served as the engine for India’s economic growth in the last few years, will continue to be strong, at a time when investment demand too is picking up.

Further, emerging markets such as Russia, Brazil and South Africa will be hurt by falling commodity prices. According to JP Morgan, India’s correlation with the Goldman Sachs Commodity Index is a mere 0.03 per cent and with the GSCI Industrial Metals Index 0.15 per cent, both below the mean for emerging markets. It’s possible, therefore, that some funds may be redirected from the commodity producers to India.

Moreover, India is also relatively insulated from a US slowdown, because it is more dependent on domestic demand compared with the export-intensive Asian countries. And finally, the fact that most funds are underweight on India allow for the possibility that the market may rise suddenly, if FIIs decide to change their stance.