Unwinding of global risk trade could result in a major sell-off in 2012.
If there is one question on the mind of almost every fund manager, it is: Will there be a landslide sell-off by foreign institutional investors?
If such a sell-off were to happen, the indices could correct by at least 15-20 per cent, as forecast by some of the foreign brokerage houses.
But haven't FIIs been selling heavily already? No, the net sell-off in equities (2011) is $186.13 million only.
Even as cumulative FII outflows in the last six months stand at $2.9 billion, many believe that there is room for further unwinding of risk trades.
To gauge the mood of foreign investors, it makes sense to look at a pattern in inflows and outflows.
Last year, for instance, a lot of exchange traded funds (ETF) invested in Indian equities between August and November.
According to fund-flow analysis done by Kotak Institutional Equities, estimated net asset allocations of ETFs in India have dropped by nearly 30 per cent this year, on the back of market corrections and large redemptions.
However, India was not the only emerging market to see outflows.
According to HSBC Global Research, inflows into US Treasuries strengthened, while outflows from emerging markets and European bonds intensified. However, ETF flows in China and Taiwan have been positive all through November.
On the other hand, allocations by BRIC (Brazil, Russia, India and China) funds to India have remained volatile, falling 1.5 per cent month-on-month.
On a 12-month basis, allocations to India are down for Asia ex-Japan funds (from 12.2 per cent to 10.4 per cent) and BRIC funds (from 16.1 per cent to 13.1 per cent).
Sequentially, FII holding in the BSE 200 (including GDR and ADR)) decreased to $184 billion (18.2 per cent) in the September quarter, compared to the $230 billion (18.3 per cent) in the June quarter.
What is worrying fund managers are the steadily deteriorating macro-economic fundamentals of the economy.
Unlike this time, India's macro-economic indicators were strong in 2008.
Corporate earnings also held up.
This time, there's little that India has in terms of a cushion, if the global situation worsens.
The reason why equities saw a massive sell-off in 2008-09 was driven by hedge funds, which were not sure of banks rolling over their debt.
This time, it seems India's fiscal and current account deficits are making investors nervous.
According to Morgan Stanley, India's current account deficit and the way it is funded (largely by capital market flows) exposes India to a global financial crisis.
If the rupee continues to be volatile, the worst nightmare of fund managers may well come true.