It’s true that opening up of capital markets i.e. attracting FIIs would improve a country’s economy, and India also opened up its markets since 1990’s. Since then FIIs invested heavily in Indian stock equity and the market’s dependency on the FIIs increased equally. With the help of globalization the stock markets around the world became correlated to an astounding degree. Now the correlation between DJ index and emerging markets indices is around 90% .
Fig. 1 shows the stock indices of BSE and DJIA since April 17th 2006. It can be observed that when there is a dip in DJIA by 1% there is almost a dip of 10% in sensex, Fig 2. The correlation between these two indices since April 17th is found to be 93%. The fact that emerging markets (majorly south Asian markets) are depended heavily on the US markets can be viewed from Fig 3. It can be interpreted that if there is a little dip in DJIA, soon afterwards markets in Japan, Hong Kong, and Mumbai will dip.
Figure 1: BSE Sensex and DJIA points since April 17th
Figure 2: DJIA and Sensex % change since last 3months
Figure 3: Stock indices of Japan, Mumbai, Hong Kong and US since last 3months
Generally Asian companies are listed through American Depository Receipts in US stock exchange. Almost all the top notch Indian companies that constitute the BSE 30 are listed through ADRs in US (there are approx 80). So if the Dow dips or rises, Indian ADRs too dance to the same tune (not always, but in general).
Its evident that globalization has interlinked countries to such an extent that any change in the major stock market will reflect changes in the others too. Trade and capital flows have increased to enormous volumes. As US accounts for more than 1/4th of the world’s GDP any little change in US stocks will immediately show on the other emerging markets. Increased investments in US will enhance software developments and BPO industries in India. Good growth in US economy will improve the tourism industry around the world. Any decision by US Fed (monetary policies) will affect the performance of other markets. Last month (May 06) when US Fed members hinted about the concerns of inflation, markets crashed across the world (of course little effect on European markets). Investors interpreted this to mean higher interest rates, more savings in the bank, lesser investments by public/firms, slower the economic growth. It may be that this is a test by US Fed to check their influence on other economies. Now US is in a position to threaten any country directly (war) or indirectly (hurting economies) and India may have to revisit their policies to reduce the influence of FIIs on the country’s growth.
Globalization brings in many advantages and Indian companies have gained hugely with the access to global capital markets. India itself is propelling with growth in all sectors because of the reforms bought in by government due to the pressure of FIIs. But there are also few disadvantages like loss of control on the nation’s economy. It would be better if RBI takes this point seriously and find out the ways to cut down the dependency of our economy on FIIs.
Inspired by an article by Swaminathan S Anklesaria Aiyar
1. Swaminathan S Anklesaria Aiyar article on June 21st, ET.
2. Y.V. Sridhar, Market Mayhem, Frontline, June16, 2006