Export-driven software firms such as Infosys (INFY.NS) and Tata Consultancy (TCS.NS) were among the biggest losers on worries the economic problems could dent demand for outsourcing.
India's showcase $76 billion software and services sector, which has already been reeling under competitive pressure and sluggish demand, counts the United States and Europe as the two biggest markets.
Still, India's largely domestic-demand driven economy is seen better placed to withstand the global turmoil, analysts said, and the main stock index pared losses to 0.78 percent after falling as much as 3.3 percent early.
"India will be impacted in terms of sentiment because of what's happening in the overseas markets," said Sam Mahtani, a London-based fund manager at F&C India Investment Company, which manages $500 million worth of Indian equities.
"Once the situation settles down a bit, India will be quite a big beneficiary of the current environment because the commodity prices are dropping which is going to help, especially the falling crude prices," he said.
The BSE index shed 132.27 points to end at 16,857.91, its lowest close since June 9 last year, with 18 of its components in the negative territory.
The benchmark has been one of the worst performers this year, having lost nearly 18 percent. In the past six days, the selloff has wiped $8 billion off the market value of all stocks on the Bombay Stock Exchange.
However, Indian equities outperformed most regional bourses on Tuesday with Korea falling 3.6 percent and the MSCI's measure of Asian markets other than Japan ending down 2.7 percent.
Falling oil prices will help in managing India's inflation, Finance Minister Pranab Mukherjee said on Tuesday. Headline inflation in June had quickened to 9.44 percent and the Reserve Bank of India (RBI) has raised interest rates 11 rises since March 2010 to cool price pressures.
"The fact that it is less exposed to the OECD economies and the fact that commodity prices are falling are two things that benefits India," Mahtani said, referring to the Organisation for Economic Cooperation and Development.
"We have been increasing our exposure...and that's very much our advice to investors, which is to look at this as an opportunity and look at the quality names."
Brent crude plunged to a six-month trough below $99 a barrel on Tuesday in a two-session drop of nearly $10, after a U.S. credit downgrade intensified fears about a global slowdown in demand for energy.
Still, India's volatility index touched a all-time high of 37 points on Tuesday -- signalling a sharp rise in investors' risk aversion.
While the U.S. downgrade late on Friday was the most obvious blow to confidence, investors have also been spooked by data suggesting the U.S. economy was stalling and Europe's ever-worsening sovereign debt crisis.
Foreign institutional investors have sold Indian equities worth about $556 million so far this month, after investing a net $2.3 billion between January and July.
Infosys, India's No. 2 software services exporter, led the losses in the market, falling 3.9 percent to 2,374.55 rupees, its lowest closing level since February last year. Sector leader Tata Consultancy ended down 4 percent at 964.80 rupees.
Energy major Reliance Industries (RELI.NS), which gets more than 60 percent of revenues from exports, dropped 2 percent to 765.30 rupees, taking its losses to about 28 percent so far this year.
Tata Steel (TISC.NS), which operates a majority of its capacity in Europe, and Tata Motors (TAMO.NS), which gets 80 percent of its profits from its UK-based Jaguar Land Rover unit, fell more than 4 percent each.
The 50-share NSE index ended down 0.89 percent at 5,072.85 points.
In the broader market, losers led gainers in the ratio of 3.4:1 on high volume of 835 million shares.
STOCKS ON THE MOVE
* Power trader PTC India (PTCI.NS) rose 4.8 percent to 73.60 rupees after the company reported a 63 percent rise in the June quarter net profit.
* Sobha Developers Ltd (SOBH.NS) dropped 1.1 percent to 242 rupees. The Bangalore-based real estate developer said after the market close on Tuesday quarterly profit fell 9.9 percent to 309 million rupees.
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