For the better part of the past four years, foreign investors have been losing interest in the Indian stockmarket. With reason too. For much of this period-save a short-lived boom in technology stocks-the Indian market has not only underperformed other emerging markets, but has also been among the worst in terms of returns to investors. The irony is that this happened despite Indian companies faring as well or as badly as their peers in other emerging markets: they not only matched-up in terms of earnings but also dividend yields.

But investing in stocks, as even novices know, is not just about dividend yields but also capital gains. The reason India's stockmarket has been performing poorly is not because there aren't good companies-there are many-but because average price-earning multiples have been steadily declining and eating into any growth in dividend yields. Naturally, this has made India a far less appealing destination for foreign institutional investors (FIIs), who typically weigh the odds of investing in any market with other similar alternatives. A number of regional and global emerging markets funds thus felt that it would be better to run a portfolio that underweighs the Indian market.

But why are price-earning multiples (p-e ratios in punters' lingo) low in the Indian market? Curiously, it has a lot to do with things other than the stockmarket. The price-earning multiple, a simple ratio of a stock's price to the company's earnings per share, measures investors' perception about future earnings. The higher the price earnings multiple, the greater the expectations of investors about future earnings. Yet price earnings ratios are influenced by subjective perceptions that go beyond the fundamentals of a company to macroeconomic factors such as country risk and fundamentals of the economy as a whole.

While the high price-earning multiple of America's capital markets in the last decade was the envy of the world, it was not only because of corporate America's stellar performance but because the American economy enjoyed a prolonged period marked by peace and prosperity. In the past four years, it has been quite the contrary in the Indian context. To begin with, the Indian economy didn't see spectacular growth during the period, but more important, there were destabilising factors galore. A string of scams in the financial market and, of course, the heightening tension in relations with Pakistan. In the last five years, even the positive impact of at least three good Union budgets-which usually contribute to a 'feel good' mood on the bourses-was negated by what followed: political instability, securities scams, communal riots, or war clouds.

Still, some FIIs did bet on India, adopting a 'bottom-up' approach to investing, focusing on companies, their fundamentals and earnings, rather than a 'top-down', macroeconomic focus. They argued that investing in India was all about a few good companies. So larger issues like poor macro growth rates did not matter. But soon many learnt the hard way that they actually did. And that poor macroeconomic indices affect investor perceptions about future corporate earnings.

To be sure though, it's not just event-risk that has made India an underperforming emerging market. Many investors, particularly foreign ones, are perturbed by rampant speculation by local operators and the growing phenomenon of day trading-where traders book profits daily-because of the volatility they cause. Besides, doubts exist about India Inc.'s commitment to better corporate governance and the recurrence of stock-related scams, which have reached near-chronic proportions. It isn't uncommon to see fund managers picking up stocks of second- or third-tier companies in other emerging markets instead of those of a top-drawer Indian company that is engaged in the same business.

The way out of this vortex is tough but not impossible. A greater emphasis by business on corporate governance, better regulation of the stockmarket and, crucially, the political will to ensure peace and stability will go far in changing the perception of foreign investors: from a discounted market to a premium one.