Katrina buoys emerging markets

Prospects for liquidity flows brighten despite weakening fundamentals

Katrina may have devastated the US Gulf coast and caused untold misery, but its effect on emerging markets may be far more benign. That's because it has restored two of the props that held up emerging markets till recently.

It may be recalled that one of the many reasons that were held to be responsible for the rally in emerging markets in the last couple of years has been the weakness of the US dollar.

That theory got knocked down a bit this calendar year, with the dollar appreciating smartly, and flows to emerging markets continuing to remain robust in spite of that. But with the dollar weakening and the rupee becoming stronger, the rationale for liquidity inflows becomes even stronger.

The second prop that led to emerging market flows was the low rate of interest in the US. Bears pointed to the successive rise in Fed rates to argue that funds would soon flow back to the US.

That theory too withered away, with fund inflows continuing to remain strong despite the hikes, but there was always the worry that the Fed tightening would have an impact sooner or later.

Now that everyone is predicting that the damage to US growth as a result of the hurricane would lead to a pause in the rate increases, the case for renewed flows to emerging markets becomes even stronger.

In the US, yields on the two-year government note registered their biggest one-week decline in more than three years as investors reassessed their outlook for interest rates hikes from the Federal Reserve.

Furthermore, it suits emerging markets if US growth continues at a more measured pace, because too hot an economy would lead to liquidity flowing to the US instead of high-growth emerging markets.

A bit of a slowdown in US growth (though not too much) would, therefore, not be unwelcome.

In short, the outlook for liquidity flows into emerging markets has become brighter, a change seen in the renewal of FII buying very recently. Earlier, during the week ending August 31, India equity funds saw a net outflow of $21.9 million, according to EmergingPortfolio.com, the first outflow in fifteen weeks.

Ironically, the improvement in liquidity outlook comes at a time when the pointers are increasingly suggesting a slowdown in earnings growth. The meltdown in the Indonesian rupiah is a case in point, and illustrates the impact of higher oil prices.

The IMF managing director has said that he sees no reason why developments in Indonesia will have a spillover effect, but he has also said global growth is at risk from higher oil prices.

Which brings one back to India. The government is fast running out of options and will have to raise fuel prices sooner rather than later. There are also clear signs of a slowdown in several of the cyclical sectors, commercial vehicles being a case in point. Yet the stock market has resolutely ignored these signals.

What this means, according to ABN Amro chief economist Abheek Barua, is that there's a greater appetite for risk, which in turn implies a re-rating of the Indian market.

Market Cap Sweepstakes: India overtakes Taiwan

India's market capitalisation has overtaken that of Taiwan. With the Sensex nudging 8000 mark, the country's market capitalisation now stands at Rs 22 lakh crore or around $490 billion compared with Taiwan's $480 billion or so.

Even in July this year, Taiwan was ahead of India with a market cap of around $510 billion vis a vis India's $430 billion, while China was at about $350 billion. But with FIIs flocking to India, the pecking order has changed.

India now ranks fifth in Asia-Pacific region and remains ahead of China ($410 billion). If FII inflows continue at the current pace, India may soon catch up with South Korea, which has a market cap of $540 billion.

Between January and now, the Indian market has gained around 27 per cent whereas China has actually fallen by about 6 per cent, and Taiwan has grown by less than 1 per cent.

FIIs continue to find the India story intoxicating and with good reason. While it is true that valuations may be stretched""according to one study India is close to becoming the most overvalued market in the region ""the fact remains that it is one of the fastest growing economies in the world. In an interesting development,

Franklin Templeton recently modified its China Fund in Canada to include Brazil, Russia and India. So, if the economy is going to continue to grow the way it is, it's inexplicable as to why India's share is a minuscule 1.26 per cent as a percentage of the world market cap.

Thus far, foreign investors have been moving money into India either to arbitrage or to test the waters. The real re-rating of the market is yet to happen.

With contribution by Shobhana Subramanian