Tuesday, March 20, 2007

Whatever goes up.......

The Indian stock market, along with the other BRIC economies (Brazil, Russia and China), has hogged the lion's share of portfolio flows into emerging markets in recent years. That has sent the markets rocketing up. The downturn, when investors get jittery and pull out, can be as severe as the upswing. ET (March 20) reports:

China, India and Russia are losing their allure for stock investors because corporate profits are showing signs of flagging, even as their economies grow at some of the fastest rates in the world.

Stock markets in the three countries are among the 10 worst performers this year. Together with Brazil, they’ve fallen twice as much as developing nations as a whole. In the past five years, each market has at least tripled, helped by an economic boom that exceeds 10% a year in China. Now, growth is stoking inflation and straining production. .....

Russia’s ruble-denominated Micex Index has surged at an average annual rate of 48% for the past five years, the best performance of the four. The Hang Seng China Enterprises Index, tracking shares of mainland companies that international investors can buy and sell freely in Hong Kong, posted average gains of 37%, and India’s Sensitive Index added an average 34%. Brazil’s Bovespa index had an annualised advance of 27% during the same period....

By comparison, the MSCI emerging-markets index rose 26% each year on average, while the Standard & Poor’s 500 Index in the US climbed at a 3.8% rate. Last year, BRIC-related stock funds garnered a net $18.7 billion. The net inflows equaled 83% of the record $22.4 billion for all emerging markets and the most since Emerging Portfolio Fund Research started compiling figures in 1995.

BRIC markets were the hardest hit during a global sell-off, sparked by a plunge in China’s mainland markets on February 27, which wiped away $3.3 trillion in value worldwide in a week. “In the short term, what people want to do is to reduce risk, and these markets are definitely going to be punished,” said Rudolph-Riad Younes, who helps oversee $58 billion as head of international equities at Julius Baer Investment Management in New York.

Is this kind of volatility bad? Well, ups and downs in the stock market do not by themselves pose any systemic risk in well regulated financial markets, such as India. The wealth effect of stock prices also tends to be small. But volatility in portfolio inflows causes volatility in exchange rates. This can be unsettling for firms.

In India, the RBI has had to intervene to limit rupee appreciation caused by inflows because it is not sure whether the inflows will continue. Whenever foreign portfolio capital exits, it causes rupee depreciation. RBI intervention increases money supply. This has to be neutralised by open market operations which causes interest rates to rise. Managing money supply and interest rates in the face of large and uncertain capital flows is a big problem for emerging market regulatory authorities.

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