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Not Made In India

India's integration into the world economy and the increasing dominance of dollars on Dalal Street have made the stockmarket prone to global factors triggering ups and downs in the Sensex
You can't be blamed for concluding that the now-exultant-now-sinking Sensex is testing both sense and sensibility. The gross domestic product (GDP) is still growing at 9 per cent plus, corporate profits are multiplying at over 25 per cent year after year and Indian shares maintain their top-of-the-chart position on returns. There is hardly a provocation on the political front. Yet the Sensex has lost 1,069 points over the last one week.

Explanations offered range from the sublime to the ridiculous, from a hike in Japanese interest rates to tinkering of stockmarket regulations in China. The connection with the Indian share prices may seem hard to fathom. Especially as the Sensex didn't even blink on the five occasions the Reserve Bank of India (RBI) jacked up interest rates during the last two years.

As former US Fed chief Alan Greenspan once said, anything can be a proximate cause for a crash or a new high. The truth is in a sense lost in translation in the jargon-afflicted world of stockmarkets. Fact is that indices are gyrating across what are fashionably called emerging economies, because they are now the playground of a common set of return-hungry investors who are moving money from developed economies to the high-growth developing world. The commonality of the fund flows has made the price movements vulnerable to common factors.

Last week for instance, markets across the east Asian time zone reacted to an interest rate hike in the Japanese money markets triggering a domino effect as markets opened in Russia and Brazil too. A 0.50 per cent would hardly fetch a sneeze in India (which has seen six 0.25 percentage point hikes in two years) but the Japanese hike unleashed a nervousness akin to what tsunamis trigger. That's because investors collect money from developed economies and funnel it to common pools such as hedge funds operating from tax havens such as the Isle of Mann or the Bahamas and other funds in Manhattan or Hong Kong where fund managers cull out allocations for different assets. Of late, commodities such as gold, and equity markets in the emerging economies such as Brazil, Russia and China (which along with India form the four fastest growing BRIC economies) have become favourite parking spots for funds owing to the super profits of as high as 30 per cent a year. As they invest in a market or pull out, the indices surge or go into a steep fall. None of which hurts until the tide turns and the foreigners dump shares en masse wrecking global markets. On average, they have sold $5 billion (Rs 22,085 crore) of Asian stocks per correction since 2003.

Analysing the impact of the 8.8 per cent fall in the Chinese markets, Dominic Price, MD and senior country officer, India and Sri Lanka, JP Morgan, says, "The interesting thing about the recent correction is it demonstrates that economies such as China in this instance, and India, have the ability to influence the direction of global markets to a greater degree than they previously did."

At home, Dalal Street has seen inflows of $35 billion (Rs 1,54,595 crore) since the rally began in 2003 which has lifted the Sensex by 271 per cent. Just last year, portfolio investments by foreign institutional investors (FIIs) amounted to $8 billion (Rs 35,336 crore). The number of FIIs registered in India has increased from about 300 in 2003 to 1,000-plus who now own 22.41 per cent of bse-100 stocks. More importantly, India's share in the moolah earmarked for emerging economies has shot up from 20 per cent to 47 per cent.

Since 2003, the Sensex has crashed by over 10 per cent on three occasions. Each time the crash was triggered by global cues and domestic factors amplified the collapses into full-fledged blood-baths. In May 2004, the NDA's loss and the emergence of the Left kicked off a domestic hammering which shaved more than 10 per cent off the already beaten Sensex in a single day. As did the massive unwinding of the hugely-leveraged positions on Dalal Street in May 2006, after a fall led by global factors. The slide was exacerbated by confusion over a tax directive from the Finance Ministry. The lacklustre Budget 2007 was the home-grown reason this time round.

In each instance, local factors combined with global triggers to mirror the carnage in the BRIC economies. That India has globalised and markets are more integrated now with global fund flows is best proved by the near-absence of impact of the Asian contagion on Dalal Street in 1998.

Not surprisingly, fund managers, financial analysts and ordinary investors are all ears every time US Fed chief Bed Bernanke speaks or the Japanese government shows a yen for higher interest rates. Experts, however, are quick to point out that while one should watch out for global factors, finally it is the performance of the local economy, of returns on portfolio investments, that determine inflows and thus the level of specific indices. "India's corporate performance has created a floor below which stock prices can't go," says Shriram Iyer, head of research at Mumbai-based brokerage house Edelweiss Capital.

In a sense the gyrations felt over the past week and earlier are the result of a thin domestic investor populace. As the Indian investor base grows, the domination effect of the dollar-driven flows could be countered with rupee resilience. As always, the antidote to volatility (besides strict vigilance) is reforms, higher growth and fatter returns. So don't be too surprised if next week, perhaps prodded by encouraging corporate results and hopefully some headline reforms, the Sensex resumes its northward trajectory. Irrational fears would probably be replaced by irrational exuberance.

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