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T.B. Kapali

Chennai, Sept. 19 Why should Indian stock markets rise and the Indian rupee gain when the US central bank lowers interest rates and major global financial markets react positively? It will be simple to answer this by saying that such a movement is proof of the strong linkages / inter-connectedness between the US, global and Indian markets.

Some observers may go farther and brand such movements as evidence of globalisation – of the financial kind. They could point to the sympathetic movements in Indian stock markets when major global markets have been on the downswing also as proof of the integral links between the two.

The truth, though, is not that simple. Sympathetic movements during major events such as the US central bank cutting / hiking rates or other global markets rising / falling are just shallow evidence of the degree and nature of relationship between different national markets. That is, event-driven moves are not fully reflective of the closeness of the link or otherwise between different markets.

There is a deeper, structural momentum to the Indian stock market’s rise and the Indian currency’s gains in response to the US Federal Reserve’s rate cut in the current instance, and more generally to global market developments. That structural momentum is provided by the fact that the Indian markets have, actually, fairly low correlations (or closeness of relationship) with some of the key global markets – both developed as well as emerging markets. That is, the inter-connection / linkages between India and the global markets are not that strong as yet after almost two decades of financial sector / broader economic reforms.

This low level of correlation provides the structural support to Indian financial markets even when economic conditions globally are strong and positive. This support gets amplified when global economic prospects – meaning conditions in such major economies such as the US, Euro zone or Japan - become weak.

In other words, the low correlation provides the platform and justification for international investors – such as FIIs – to include Indian stocks also in their portfolio in the best of times as part of a portfolio diversification strategy. The preference for Indian investments possibly gets strengthened when prospects in the major economies weaken or deteriorate as seems to be happening currently.

As the table shows, the correlation between the monthly US dollar returns on the S&P 500 (taken as a global bellwether) and some key emerging markets’ indices such as the BSE Sensex has been around 0.50 in the past 5 years. This means that just around 25 per cent of the performance in the BSE Sensex is influenced by what is happening in the US and 75 % is determined by economic conditions obtaining specifically in India. The Indian market’s relationship with other emerging markets is also not that strong as the table shows.

The returns from the Indian markets, in relation to that from the S&P 500, in the past 5 years provide evidence of the still weak links between the two. The Indian markets have delivered monthly returns of 3 % whereas returns from the S&P 500 are just around 0.8%. The table also shows that the level of risks in the Indian markets – measured by the variability of the returns – is higher than that in the US markets. That is, higher returns are matched by higher risks.

On the whole, Indian markets continue to enjoy the benefit of being not that closely integrated or correlated with major global markets. It is, therefore, no surprise to see the Indian stock markets rising and the Indian currency gaining when the US Fed cuts rates.

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