The Decoupling Myth

As the European sovereign debt crisis flares up and the U.S. economy teeters on the brink of a double-dip recession, the question is how badly this will affect the Indian markets. The debate on whether we are still tightly coupled with the developed world markets, or have decoupled, has revived. Since India’s GDP growth is likely to be in the 7-8 per cent range while that of developed nations will be in the 1-2 per cent range or lower, will our markets continue to grow despite the troubles in the advanced world? Proponents of the decoupling theory argue that global capital can’t lie idle: capital will seek out investments offering the highest rate of return. Since developed world equity markets have been underperforming, all that capital must be invested somewhere. What better place than high-growth emerging markets such as those of India? Alas, things don’t quite work that way. While India’s high GDP growth rate is a hard fact, perceptions also count — the perceptions of those who control the money, that is, fund managers from US and Europe. India may have a high growth rate, but it is part of the emerging market basket. And in the perception of Western fund managers, emerging market equities are more risky than those belonging to the developed world. Whenever risk aversion rises, money flows out of risky assets and into safe havens. Fund managers reduce their allocation to equities, and more so to emerging-market equities. In the most recent episode, money was pulled out of equities (especially that invested in “risky” emerging market equities) and invested in cash. And the preferred currency was the U.S. dollar. (The Swiss fran

This article was originally published on November 26, 2011.