India equities - what now?

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Emerging Markets-14.06-6.44 Brazil-23.21-24.66 Turkey-31.68-23.08 Thailand-9.30-21.47 China-16.64-19.44 India-15.08-16.34 Peru-20.07-15.29 Argentina-23.08-14.76 Chile-8.76-11.16 South Africa-14.45-7.58 Taiwan-11.79-2.83 Korea-16.18-2.22 Malaysia-13.52-1.39 Philippines4.060.28 Indonesia-5.010.32 Poland-7.090.74 Jordan-0.864.08 Pakistan0.266.77 Venezuela-9.796.89 Israel (domestic)-0.367.06 Morocco-0.277.47 Mexico-9.797.93 Sri Lanka0.238.04 Czech Republic-9.398.73 Israel-1.389.13 Russia-14.4310.72 Israel (non-domestic)-5.9817.89 Egypt-1.3718.36 Hungary-2.3421.05 Colombia-4.9833.69

Source : MSCI

 Back home, foreign institutional investors (FIIs) have bought stocks worth Rs 15,075 crore on a net basis this year. However, in the month of May alone there was a net outflow of Rs 3,460 crore.  How bad can the going get for emerging markets and how is India poised relative to other emerging markets considering economic realities today? Here are some key pointers:  

• Emerging market economies will continue to outpace developed markets in terms of real GDP growth, making them relatively attractive.
• But money is moving out of emerging markets, and into developed markets. While EMF lost 6.13 per cent in four weeks, developed markets gained 0.13 per cent during the period.
• There is some amount of churning within the emerging markets region with countries like Russia attracting more attention.
• Portfolio flows to emerging markets are likely to increase, according to the forecast by the Institute of International Finance (IIF). Korea will attract about 40 per cent of flows. India should see $7 billion inflows.

 The showing so far
Year-to-date the MSCI Emerging Markets Free Index has lost 6.45 per cent while the developed countries index has gained 1.23 per cent. Quarterly numbers also show similar results.  In the past quarter, India recorded the seventh largest loss in the emerging markets group. Countries which were worse than India were Turkey (31.68 per cent), Brazil (23.21 per cent), Argentina (23.08 per cent), China (16.64 per cent), Korea(16.18 per cent) and Peru (20.07 per cent).  But the good news is that baring three countries - Philippines, Pakistan and Sri Lanka - all emerging markets recorded losses in the last quarter till date (See table: How emerging markets fared).  Some fund managers simply blame it on the precarious position equity markets were in the beginning of 2004.  "Emerging markets took time out to consolidate from unusually high levels of last year," says Chetan Sehgal, senior vice president, Templeton Emerging Markets Group. But what triggered the sell-off is what Sehgal calls the new ICE (interest rates, China and elections) meltdown.  Why emerging markets are nervous...

• Expectations of a rise in US interest rates have caused some funds to exit emerging markets. This is natural. Because if growth picks up in the US and the Fed hikes interest rates, funds will find it more profitable to divert their attention to the Big Brother.
• The other concern stems from trends in international oil prices and the impact it could have on global growth. The brent crude oil price touched highs of $41 per barrel in recent times from levels of $33 in the beginning of the year.

 Sustained high energy costs would pump inflation and slow growth. "Central banks would have the difficult task of deciding how to respond to such a situation: Should they support output or suppress inflation?" asks Sanjeev Sanyal, director and senior economist (Asia), Deutsche Bank. Rising oil prices will also strain budget deficits in oil consuming countries, putting pressure on growth.  "The earnings story in emerging nations will not look attractive if oil prices continue to rise," agrees Andrew Holland, chief administrative officer and executive vice president (research), DSP Merrill Lynch. Though leading economists believe that there will be a mean reversion in oil prices eventually, the short-term trends are difficult to assess.  

• Slow-down in the Chinese economy is another concern. China - being the largest manufacturing hub - consumes large amount of resources. A slow-down there means commodity prices are under pressure. This has affected commodity prices for all emerging nations.

 India, too, witnessed a drop in steel prices. However, experts say even though China will grow at a slower pace, it will remain the fastest growing economy in the world.  "We expect commodity prices to rise in the second half of this year," says Holland.  Sanyal also agrees: "Even if the government succeeds in slowing the red-hot economy, it will still be growing at an astonishing rate." Sanyal is more concerned about long-term problems with the country's financial system and the misallocation of resources.  ...and why they shine

• Despite these concerns, emerging markets are expected to clock high economic growth numbers. Emerging markets (all nations combined) real gross domestic product (GDP) is projected to grow by 5.8 per cent in 2004, higher by around a per cent compared to last year, estimates IIF.

 Developed nations like US, Japan and UK are expected to grow at 4.4 per cent, 2.8 per cent and 3.3 per cent respectively.  The emerging markets outlook reflects an acceleration of growth in Latin America, especially fueled by an improving Brazilian economy. Most Asian economies are in for a steady growth in 2004, although growth in China and India is expected to be lower than that of the exceptional performance in 2003.  Growth in emerging Europe is projected at 5.3 per cent this year, nearly the same as in 2003. The Africa-Middle East region is likely to grow at 3.3 per cent in 2004, close to the average of the past six years.  The Asia-Pacific region is expected to remain stagnant at 7.3 per cent in 2004 (7.1 per cent in 2003). Growth in China is likely to decline marginally from 9.1 per cent.  Real GDP growth in India is projected to moderate to 7 per cent this year from a very fast pace in 2003, which reflected a sharp turnaround in agricultural output. Growth in Korea, despite a highly charged and uncertain political situation, is expected to accelerate to 6 per cent in 2004 from 3 per cent in 2003.  

• The healthy economic growth rates are likely to keep flows strong as per the forecast by IIF. Net private capital flows to emerging market economies are likely to grow to $225 billion in 2004, an increase of over 15 per cent from $194 billion in 2003 ($128 billion in 2002).

 The Asia/Pacific region is expected to rope in almost 50 per cent of total flows to emerging markets (See chart: Fund flows on page 1). Improved corporate profitability on the back of healthy macroeconomic conditions and healthier balance sheets should be the driver for strong net inflows through 2004.  Within all Asia/Pacific emerging markets, India is expected to garner $7 billion on the back of rising corporate profits and improving economic growth prospects.  Following a surge to $10 billion in 2003, net portfolio equity inflows this year are projected at a high but more sustainable level, according to IIF.  "The country is now in a position to generate GDP growth of 7 per cent per annum even with a modest reform effort. India and China are clearly the top favourites at this moment despite all the concerns,