What has been the impact of the participatory note (P-Note) restrictions on the Indian market?

One view is that it’s responsible for the slowing down of foreign institutional investor (FII) inflows, and it’s true that FII funds flow into the Indian market turned negative in November. But the numbers don’t seem to bear out this theory.

Data culled from Bloomberg show that while the Indian market saw an FII outflow of $1.1 billion (Rs4,345 crore) last month, that’s peanuts compared with the money flowing out of South Korea or Taiwan.

What’s more, even the sell-off in August by FIIs in the Indian market was relatively muted compared with South Korea and Taiwan. And finally, flows into the Indian market were also greater than in these markets during the rebound in September. All this has had its impact on market performance.

As on 6 December, the Morgan Stanley Capital International (MSCI) India index, for instance, had risen by 18.62% in the past three months, compared with a negative 0.04% for the MSCI Korea and -5.34% for the MSCI Taiwan index.

In fact, three-month returns on the MSCI India index were second only to Indonesia among emerging markets.

It’s not a coincidence that a recent Citigroup Inc. report says that India and Indonesia are the two best places to hide from a US slowdown, from a robust domestic demand story point of view. Their loan growth and investment trends look strong as well as sustainable. Indonesia and Vietnam markets are two Asian markets that saw net foreign inflows last month.

Could it be that the divergence in fund flows and the performance of different markets reflect how exposed they are to a US slowdown and to the subprime contagion?

That seems very probable: In Asia, export-oriented economies such as Korea and Taiwan are far more exposed to a US slowdown than a country like India. Globally, contrast the negative returns in the last three months for the MSCI USA and MSCI UK indices with the returns on India.

Simply put, investors have not been lumping all emerging markets together, but instead have been discriminating among markets on a rational basis, depending on their growth prospects. Whether the market continues to go up will depend on the extent of the liquidity being withdrawn by the credit crunch in the developed markets. But if the trends of the last three months are any indication, India should outperform both developed and most other emerging markets.

Indian banks are dwarfed by their Chinese peers, especially when it comes to market capitalization. To take an example from a recent Citigroup report, ICICI Bank Ltd, the largest Indian bank by market cap, had a capitalization of $30.9 billion as on 26 November.

On that date, Industrial and Commercial Bank of China (ICBC), the largest Chinese bank had a market cap of $329.8 billion, 10.6 times that of ICICI Bank. China Construction Bank, the Chinese No 2, had a market cap of $226.5 billion, compared with $29.8 billion for the Indian No 2 bank, State Bank of India.

Among Hong Kong banks, Hang Seng Bank Ltd’s market cap on that date was $35 billion, more than any Indian bank.

However, apart from the Chinese and Hong Kong banks, Indian banks were the biggest by market cap in the region. South Korea’s biggest bank, Kookmin Bank, had a market cap of $22.5 billion. DBS Bank Ltd, the largest Singapore bank, had a market cap of $20.7 billion on that date. Indonesian, Taiwanese, Thai and Malaysian banks were all much smaller than Indian banks.

The report shows that India has some of the most expensive banks in terms of price-to-book (P/B) ratio value, with Kotak Mahindra Bank having a P/B ratio of 7.41, according to Citigroup’s forecasts for calendar 2007. Other Indian banks with high P/B ratios are Yes Bank Ltd (5.71), HDFC Bank Ltd (5.49), Centurion Bank of Punjab Ltd (4.38) and Axis Bank (4.31). Using this criterion, China’s most expensive bank is China Merchants Bank , with a P/B ratio of 7.12, but the other banks are much cheaper, with Bank of Communications being the next most expensive with a P/B ratio of 4.28.

In Hong Kong, Hang Seng Bank is valued at a P/B ratio of 5.33. Korean banks all have P/B ratios below 1.4, while the Singapore and Thai banks have P/B ratios below 2. Only a couple of Indonesian banks have a P/B ratio of slightly more than 4.

Perhaps the high P/B ratios are justified by high return on equity? Not really, quite a few of the Chinese, Hong Kong, Indonesian and Korean banks have a return on assets above that of Indian banks.

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