Indian Equity Markets : Low correlation game.

What a tremendous show of strength and resilience by Indian Equity markets.  Not that they are reaching astronomical heights but low correlation with the weakness in the world markets is a definitely a positive from both Indian and Global investor perspective.

In a period of weakness in the developed world, particularly in Eurozone over looming sovereign debt crisis and thinly capitalized financial institutions, quakes and aftershocks are increasingly been felt both in the debt and equity markets worldwide.  A lot of negative global news has queued up in this week (US consumer confidence index, China’s growth rate tapering off and lack of clarity over the extent of damage in Eurozone) and equity markets have been volatile in pricing these risks and aftershocks. The world markets have ‘slumped’ more than a couple of time in the last one week while the Indian markets in the time of global weakness have held firm and shown resilience.  

The resilience shown by Indian Equity markets is not spurious and is fueled by strong fundamentals and increased focus on second generation policy reforms. The government is going through an extraordinary spell of very sound policy making which previous regimes have given a miss. Deregulation of oil prices, capital market reforms, fiscal prudence and proposed tax reforms have instilled increased confidence in a system which has always been plagued by bureaucracy and red tapism. There’s so much of positive news outflow in the Indian markets whether its in the form of a policy reform or government intention to push forward the reforms that Equity Markets have little reason to panic or price in the global weaknesses. India is still strongly integrated in the world economy and its significance is only growing. So why is this low correlation with the world markets?

The reason could be one, the Financial Institutions in India are in good shape and there is no concern whatsoever over a looming debt crisis. The concerns over liquidity are eased off and RBI has shown maturity in maneuvering its monetary policy. Two, the job market is strong and there is strong domestic demand. India is a net importer (rather I used it as a negative feature in one of my recent blog posts) and this insulates its domestic producers from vagaries of world demand.

Going forward it makes even more sense for a foreign investor to have Indian Equities as an asset class in their portfolios. Low correlation with world equities is likely to persist over time and having a low correlation asset in the asset will certainly drive down the over all risk of the portfolio. “Man” talks of no Tobin Tax on FIIs and FDIs, but he will mince his words as strong inflows are likely if the low correlation persists.