A very clear trend has been visible in the markets this year: While all markets have seen gains, emerging markets have gained far more. As on 22 December, year-to-date returns in dollar terms were 26% for the MSCI World Index, compared with 68% for the MSCI Emerging Markets Index. For MSCI India, the year-to-date gain is a huge 91%. On Thursday itself, both of India’s major equity indices closed at year-long highs. Small wonder, then that, talk of decoupling is back.
Decoupling was the rage in late 2007 when, despite the crisis having surfaced in the West, markets in India and China went on to scale euphoric heights. The argument then was that since the crisis would lay low Western economies, where else would the money flow but to high-growth emerging ones. That line of reasoning was demolished when the tremors from the collapse of Lehman Brothers were felt by economies around the world, regardless of how far away they were from the housing and bank collapse in the West.
Illustration: Jayachandran / Mint
In the last quarter of 2008, the fact that markets were global and that all economies were enmeshed in a global network of trade and finance was brutally driven home. Curiously, though, the logic now being used to argue for a decoupling is almost the same as in 2007. The argument is that since almost everybody agrees that the Western economies have a period of sluggish growth ahead of them while they reduce debt, and since interest rates in those economies are abysmally low, the only place investors can get a decent return is by investing in the new Bric (Brazil, Russia, India and China) powerhouses.
Nobody will now argue that decoupling would hold under conditions of worldwide panic. Nobody will say that the developing economies can decouple under conditions of a severe recession in the West. But under more normal conditions, growth will be higher in emerging markets and that will mean more funds flowing to them. In short, if the US has pneumonia, the world is certain to go into a coma, but it will no longer catch a cold if the US sneezes.
As the share of emerging markets in global gross domestic product rises and as their markets become more efficient, their share of market capitalization, too, will increase. That does not mean emerging markets will always outperform—valuations are also important. That does not mean emerging markets will not have to make many changes for decoupling to become sustainable—China, for instance, will have to give up its addiction to export-led growth. But it does mean that, over the longer term, emerging markets will give higher returns. That is all that decoupling can stand for after its baptism by fire during the crisis.
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