Last week’s rally has led to the MSCI India Index becoming the top performer among the MSCI Emerging Market indices this year, with the index up 57.94% year to date. It’s the second best performer this year among all the MSCI indices except Sri Lanka, which is classified as a frontier market and is up a huge 125%, thanks to the end of its civil war. In contrast, the MSCI Emerging Markets Index is up 31.86% year to date, the EM Asia Index 39.63%, while the World Index is up just 4.68%, the same as MSCI USA.
While many fund managers have been warning about the increasingly high valuations in India and China, others have been talking of the reflation trade leading to another bubble in Asia. Doug Noland, portfolio manager at the Prudent Bear fund, has pointed out that China’s second quarter growth in foreign exchange reserves has been $178 billion (Rs8.6 trillion), exceeding even the $154 billion quarterly rise in early 2007, at the height of the last boom. Flows of “hot money” have increased substantially. As Noland puts it, “The maladjusted US bubble economy is sustained by $2.0 to $2.5 trillion of new credit—credit that must largely be issued or guaranteed in Washington. This reflation (aka credit inflation/currency devaluation) drives massive flows to China, Asia and the emerging markets.”
MSCI India Index is the second best performer this year among all the MSCI indices except Sri Lanka, which is classified as a frontier market and is up a huge 125%. Sandeep Bhatnagar / Mint
Morgan Stanley economists, in a research note on China titled “Policy-driven decoupling: Upgrading our 2009-10 outlook”, argue: “The next 6-12 months will likely feature a mix of growth acceleration and low inflation against the backdrop of a relatively stable policy stance, a macroeconomic environment that is conducive to asset price reflation, in our view.” Realty prices in China have already started rising.
As the economies of the West take time to work off their credit boom-induced excesses and as the economies of China and India recover, fund flows are likely to continue to prop up stock prices in Asia and today’s valuations may no longer seem very challenging.
In India, after the disappointment over the Budget, the door was open for positive surprises, which is exactly what happened last week as encouraging noises were made on disinvestment and on several reform Bills in Parliament. True, the outperformance of the Indian market increases the risk of a correction. The markets have already bought into the recovery and reform story, and much will now depend on the pace at which these things happen. But the recent rebound shows that liquidity will support the markets at every dip.
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