Why India needs to distinguish itself from other emerging markets

Govt's efforts to separate India from other emerging market is yielding results as can be seen in the sharp rise in FDI

Equity markets globally are witnessing selling pressure, but the effect is more pronounced in emerging markets. Falling oil prices is resulting in oil producing nations withdrawing their savings from financial assets. Simultaneously, a slowdown in China is resulting in funds being withdrawn from emerging market funds. In the sell-off, India’s relatively stronger fundamentals are being overlooked.

Uday Kotak, the executive chairman of Kotak Bank, said in an interview: “It is time we pulled ‘I’ out of BRICS. Indian must walk alone. If you are today clubbed with Brazil, Russia, even China, it is not a good company to be in. This is India’s opportunity.”

Unfortunately, a substantial amount of foreign money is invested in India through Emerging Market Funds ETF’s (Exchange-Traded Funds). These funds allocate resources to countries based on its weightage. Take for example the Vanguard FTSE Emerging Markets ETF, which is the largest emerging market with over $30 billion in assets. The fund’s exposure to China is 27%, Taiwan (which is largely dependent on China) accounted for 14% of its exposure while India came in third with 13% of the portfolio’s exposure.

Thus, any redemption in the ETF would result in the fund manager selling their asset across all countries in order to maintain the country weightage. Indian markets unfortunately get trampled on account of the selling.

Redemptions in 2016 have picked up substantially as compared to August 2015, which saw the largest redemption in the previous year.  According to a JP Morgan report, retail investors were heavy sellers of equity funds for two consecutive weeks in January 2016. Selling of equity funds, including mutual funds and ETFs exceed $25 billion over the past two weeks (weeks ending January 6th and January 13th). These figures would increase as many mutual funds have not reported their flows yet. ETFs alone accounted for selling of $16 billion in the two weeks of January 2016 as compared to $11 billion in August 2015.

The other group that has been a seller in the market are Sovereign Wealth Funds (SWF). A report points out that SWF’s especially from oil producing countries are selling their savings in financial assets to recoup the losses made by selling oil. Oil prices have crashed and are expected to remain low for some more time, which might result in further selling from these funds.

While some SWFs invest in markets through ETFs a large number of them invest in emerging market by following indices like the Morgan Stanley Capital International (MSCI) to park their money.

It’s the combination of selling from both these fronts that is causing a panic in global market. Among the two, SWF selling is one to be feared. ETF selling is on account of redemptions by investors who want to reallocate their portfolio, but SWF selling is by countries that desperately need the money to balance their budget and meet their daily expense. They would not be too keen on redeploying their money in India despite its strong fundamentals, but ETF money can be re-routed.

Had India been treated as a separate investment entity, the selling would not have been as severe. Indian economy has its own set of problems with a weakening currency and toxic quality of banking assets. But there are sprouts of growth visible in a number of sectors, which will trickle down to other parts of the economy over time. But despite relatively stronger fundamentals, Indian markets are among the worst performing globally. As Kotak rightly pointed out India must walk alone. There need to be more India focussed funds and ETFs to take advantage of growth opportunity in India.

The government's efforts to separate India from other emerging markets are yielding results as can be seen in the sharp rise in foreign direct investments (FDI). A similar effort by both the government and the financial sector is needed to channelise FII investment in India which is leaving the shores unintentionally. Collateral damage is how Indian markets performance can be described in the global scenario.