India's correlation with global markets goes down; reaches nearly 10-yr low

A shrinking correlation between financial markets in India and those in the rest of the world is one reason to buy its assets.

The weighted average correlation of India’s currency, bonds and stocks with those in other global economies fell to 0.32 last month, approaching a more than 10-year low of 0.29 set in November. The reading was as high as 0.68 in 2010, data compiled by Bloomberg show. Global investment managers say this divergence provides them with an asset class that can smooth out returns in their portfolios.

“India has seen less correlation to major global markets for a range of reasons such as the domestic nature of its economy, less sensitivity to the global cycle, and more recently, increased flows from local investors,” said Manraj Sekhon, chief investment officer at Franklin Templeton Emerging Markets Equity in Singapore. “India historically provides very useful ballast in global portfolios.”

The disconnect is most pronounced in the bond market, where India’s 10-year yields have almost no correlation with a portfolio consisting of global sovereign debt.

When Donald Trump’s unexpected US election victory pushed up the yield on the Bloomberg Barclays Global Treasury Index by 23 basis points in November 2016, India’s 10-year yield fell 55 basis points. In Indonesia, whose bond market is often compared with India’s, the move was more closely aligned with the rest of the world as yields jumped 89 basis points.

‘Idiosyncratic’ Market

“The idiosyncratic bond-market characteristics are driven largely by domestic investors where only local growth and inflation dynamics, policy-rate expectation and supply-demand dynamics matter,” said Lin Jing Leong, an investment manager at Aberdeen Standard Investments in Singapore. Other factors include the zero percent weighting for rupee bonds in many global indexes and India’s restrictions on debt investment, she said.

That’s not to say India is totally divorced from global trends. The tremors of fear than ran through emerging markets in the past month pushed up bond yields in Asia’s third-largest economy just as it did in other developing countries.

While Indian stocks are more closely correlated with their global peers than are the nation’s bonds or the rupee, the link has declined from a high reached in 2010. It may drop further after three national exchanges earlier this year decided to cut ties with their foreign counterparts to maximize trading at home.

The correlation between Indian and global markets was calculated based on monthly changes using a rolling 60-month basis. Variables include the dollar-rupee exchange rate compared with the dollar’s nominal effective exchange rate; the yield on India’s 10-year bonds versus the Bloomberg Barclays Global Treasury Index; and the MSCI India Index of shares versus the MSCI ACWI Index.

To compute the average correlation of the three asset classes, the currency was given a weighting of 50 percent, while the weighting for stocks and bonds was calculated based on the liability side of India’s international investment position to take account of the difference in foreign ownership.