A gush of liquidity from foreign investors has suddenly changed the fortunes of Indian shares, making the Bombay Stock Exchange (BSE) Sensex the best performing index among global peers since the calendar year began.

After losing a quarter of its value in 2011, the Bombay Stock Exchange (BSE) benchmark, the Sensex, has gained 11.5 per cent this far in January.

The 30-stock index last closed at 17,233.98.

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Returns for dollar investors are even sweeter, thanks to a 7.6 per cent appreciation of the rupee against the US currency in this year so far. In dollar terms, the Sensex has gained 20.4 per cent in the year to date, as measured by the Dollex 30 index.

The present rally in Indian shares is driven by foreign funds. Foreign institutional investors (FIIs) have pumped Rs 10,400 crore (Rs 104 billion) in this year so far, Securities and Exchange Board of India (Sebi) and BSE data, compiled by the BS Research Bureau, showed.

Last year, they had pulled out a net Rs 3,418 crore (Rs 34.18 billion) as high interest rates, governance deficit and corruption scandals soured investors' mood.

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Flows into India-focused equity funds were the highest in 54 weeks during the week ended January 25, according to Boston-based fund tracker EPFR Global. In contrast, both domestic institutional investors (DIIs) and retail investors have been net sellers in this month.

DIIs, which include banks, domestic financial institutions, insurance companies and mutual funds, have net-sold shares worth Rs 5,961 crore (Rs 59.61 billion) in this month so far, BSE data showed.

Retail and wealthy investors, which come under the 'clients' category, have also been sellers, to the tune of Rs 309 crore (Rs 3.09 billion) in January so far.

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Reasons

"The flows (from foreign investors) are probably a reflection of the fact that some investors are finding India attractive after last year's declines and increased global risk appetite," said Grant Bowers, portfolio manager and vice-president at Franklin Equity Group.

The European Central Bank's (ECB) massive liquidity injection last month has boosted sentiment for stock markets across the world. Hong Kong's Hang Seng index has soared 11.2 per cent, Brazil's Bovespa has gained 10.8 per cent and South Korea's Kospi has added 7.6 per cent in this year so far.

The ECB last month pumped in $623 bn in three-year loans at one per cent interest in the banking system, reducing concerns about a credit crunch and helping to shore up demand in recent auctions in the euro zone. The central bank is expected to hold a similar auction of unlimited three-year cash next month.

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Back home, investors have flocked to capital goods, banking and real estate stocks on expectations of loose monetary policy from the central bank.

Last week, the Reserve Bank of India reduced the cash reserve ratio, the amount of deposits lenders need to set aside as reserves, to 5.5 per cent from six per cent.

It, however, left the benchmark repurchase rate unchanged at 8.5 per cent. "The market mood remains positive, thanks to strong foreign inflows. Valuations are reasonable and the results season is also shaping well," said Raamdeo Agrawal, joint managing director at Motilal Oswal Financial Services.

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So far, the rally in Indian shares has been largely due to improvement in global risk appetite. However, for it to sustain, the government will have to rein in the fiscal deficit, experts say.

Also, "for the rally to sustain, government will have to implement economic reforms," said Nirmal Jain, chairman of IIFL.

Market participants believe a favourable outcome in the coming assembly elections of five states will give the Congress-led government more freedom to push such reforms.