That emerging economies such as India are doing far better than the West is common knowledge. It has also been the received wisdom for quite some time that growth in the advanced economies will be lacklustre for years to come—the New Normal is now a buzzword. So there’s no reason why the prospects of higher growth should suddenly lead to a rush of funds to emerging markets.

What’s more, the inflows have increased at a time when the purchasing managers’ surveys are showing the growth momentum is flagging. Upward revisions to earnings estimates by equity analysts are no longer coming in thick and fast. In short, at first glance the rush of funds appears to be the result of “push" factors in the developed economies, rather than “pull" factors in emerging economies.

What exactly has changed recently in economic conditions in the West? The fears of a double-dip recession appear to have taken a back seat for the moment, although the US Federal Reserve, in its meeting last Tuesday, reiterated that the pace of recovery is proving to be slower than previously anticipated. In Europe, the worst fears of contagion from the debt crisis in some of its smaller member-economies have abated, although spreads on the bonds issued by these governments have gone up again. In short, there’s a feeling of relief that investors’ worst fears are unlikely to come true.

Also See | Manas Chakravarty’s earlier columns

What about that old favourite, global liquidity? There are many ways to measure global liquidity, but the problem with them is that there is no agreement on what is the appropriate gauge of money supply. Besides, what’s new about it? We all know that central banks in the developed world have been keeping their policy rates low for a very long time and talk of a new round of quantitative easing has been around since at least mid-July.

Graphic: Paras Jain/Mint

But why should the money come to emerging markets such as India? Are they not too expensive? One trigger could be the weaker dollar—the dollar index started declining from the middle of June. But the more fundamental reason could be in a Goldman Sachs research report released this month. The report says the share of emerging markets in global market cap will increase from 31% now to 44% by 2020 and by 2030, they will account for more than half of global market capitalization. The share of the Bric (Brazil, Russia, India, China) countries in global market cap is projected to rise from 18% to 30% by 2020 and to 41% by 2030, thanks to higher gross domestic product growth and a deepening of the capital markets.

While these are long-term forecasts, they also signal that institutional investors need to allocate more funds to emerging markets. The report says that developed country investment funds currently hold 6% in emerging market stocks out of their total equity allocations. That is way below the emerging markets’ share in global market cap. Nor is Goldman Sachs the only broker to point this out. At the Franklin Templeton Emerging Markets Conference held in June this year, Mark Mobius said that institutional investors on an average allocate just 3-8% of their portfolios to emerging market stocks, while the share of emerging markets in world market capitalization is around 32%. It’s important to remember, though, that the Goldman Sachs paper also warns against overpaying for growth.

Nevertheless, liquidity is likely to remain strong in the near future. That’s not only because of the very low bond yields in the US, but also because the Federal Reserve seems to be worried about deflation in its latest statement issued last Tuesday, which keeps alive the hope of another bout of quantitative easing, by buying bonds and releasing further liquidity into the system. That will support asset prices.

Manas Chakravarty looks at trends and issues in the financial markets. Comment at capitalaccount@livemint.com

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