India's economy is showing early signs of recovery which, when combined with the country's reliance on domestic demand and recent government initiatives, will help boost sentiment for local shares, according to Teera Chanpongsang, portfolio manager of Fidelity Funds' India Focus Fund.

"Investors in India have responded positively to better-than-expected economic growth in the first quarter of 2009, signs of recovery in the global economy and favourable political developments," says Chanpongsang, who looks after emerging market investments from Hong Kong.

Foreign funds have invested more than $7 billion so far this year, compared with the net outflow of more than $13 billion in 2008.

India is one of the fastest growing among large emerging economies of the world. Its GDP expanded by 5.8% in the first quarter of 2009, at a time when the global economy faced a recession. The International Monetary Fund expects India to expand by 5.1% in 2009, at a time when the world economy is projected to grow by 0.5% and emerging economies by an average of 3.3%. 

Chanpongsang says he is seeing early signs of recovery appearing in India's stock market.

"Government spending remains strong while private consumption and investment growth accelerated when compared to the previous quarter," he says. "Industrial production rebounded in May and the Purchasing Managers' Index was recorded above the expansionary threshold of 50 for the fourth consecutive month in July. Automobile sales growth in the country has also improved this year."

Others share Fidelity's optimism over India. Earlier this month, Credit Suisse unveiled a new target of 17,000 for the Sensex. In June, BNP Paribas recommended its clients to reduce their exposure to China, which it has lowered to neutral from overweight, and increase their allocations to India, where the bank remains overweight. BNP Paribas' own target for the Sensex is 16,500. The Sensex closed at 15,240.83 on Friday.

Also earlier this month, Boston-based financial research and consulting firm Celent noted that while India's equity market capitalisation is still some way off the 2007 high of $3.3 trillion, it is expected to exceed 2008 levels in 2009 at $1.9 trillion.

Fidelity's $2.4 billion India Focus Fund, meanwhile, is overweight in the consumer discretionary, financials and industrials sectors.

"I also like the technology services sector and am expecting it to do well in the long term, as the global economy improves and companies outsource more to cut costs," Chanpongsang says.

On the political front, Chanpongsang describes India as stable, particularly after the new government won a strong mandate in the Union elections held in May this year, which he says has increased the likelihood of speedier economic reforms and prudent fiscal policies.

Chanpongsang believes India's stock market will continue to perform well relative to others in Asia over the next three to five years.

"I believe Indian equity markets should benefit from the country's strong economic fundamentals over the long term," he says. "Favourable demographics, lower reliance on exports relative to regional peers and strong domestic consumption trends bode well. A stable government at the centre for the next five years is expected to drive reforms and spend more on infrastructure development."

Chanpongsang acknowledges that stock valuations have reached mid-cycle levels after the recent rally, but this comes with an upward revision in corporate earnings forecasts. In the first seven months of the year, India's Bombay Stock Exchange Index (Sensex) benchmark index was up 62.43%, making it the third best performing market in Asia next to China and Indonesia.

"Prudent stock selection is very important in such an environment," he says. "Valuation anomalies exist and I am still finding stocks that have attractive valuations and show higher than average growth relative to the industry and market."

Fidelity International caters to investors outside the US. The fund house has been in Asia for 40 years, employing more than 4,000 people and in 23 locations including Japan, Korea, Australia, Hong Kong, Taiwan, Singapore and China. The business manages around $180 billion.