An emerging risk

Higher risk aversion for emerging markets could hurt India too.

The Sensex has had its worst January-March quarter in its history giving up about 23 per cent. But it's not just India that has underperformed, other emerging markets too have fared poorly.

Since 2002 emerging markets have clearly beaten world equities, with a few interruptions.

But in the four months starting November 2007, emerging markets fell by 16.1 per cent compared with a 13 per cent decline in the MSCI AC World Index. After $40 billion worth of buying in 2007, emerging markets have seen an outflow of approximately $20 billion in the March 2008 quarter.

According to a Citigroup Global Markets report, investment flows show evidence of a cooling in enthusiasm towards emerging market, although there is as yet, little sign of investor panic.

The report notes that while in recent years outflows have tended to taper off, if they continue or accelerate in the coming weeks, investors confidence in the ability of emerging markets to outperform in this environment may be shaken, causing the region to de-rate further.

Among the BRICs markets fund managers, so far, appear to have been overweight on India and China and underweight Brazil, depsite its strong performance.

However, in a situation where the markets de-rate further, the Asian markets, in particular India and China ,appear more exposed, according to the report.

As of now the Sensex still trades at a premium to other markets. At 15,807 the BSE Sensex trades at 15.7 times forward earnings while Taiwan, is valued at about 13.6 times and Korea trades at less than 13 times.

India's premium is justified given the better earnings visibility, superior returns on equity and increasing depth and liquidity--- India now accounts for 2.14 per cent of global market capitalisation and ranks tenth in the world.

However, the premium could shrink if there is a slowdown in earnings growth. That today appears to be the bigger risk to the markets.