India Regulator Spurs Selling

A late-day recovery stanched some losses, but a derivative ruling halted Asia's strong trend.
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Asia markets were pulled sharply into the red Wednesday, prompted by India, which plunged 9% on the open after regulators said they would limit trading in derivatives used by foreign investors. Trading was suspended for one hour to control the hemorrhage.

The derivatives, known as participatory notes, allow foreign investors to trade anonymously in the Indian markets and have in large part accounted for gains of 55% on the Bombay Sensitive Index, or Sensex, since March this year.

"A lot of foreign investors operate in India indirectly, and now the kind of money flowing in is so humongous, we don't know what the quality of that kind of money is," says Jayesh Shroff, a fund manager at SBI Mutual Fund in Mumbai, which has $6 billion under management. "We are trying to get a check on those kinds of inflows."

The Sensex later recovered to close down 336 points, or 1.8%, to 18,715.82, after clawing back 1,047.92 points, or 8.1%, from its lows, but Indian shares were hit hard.

Tata Motors

(TTM) - Get Report

fell 1.6% to 808.25 rupees, while in financials,

HDFC Bank

(HDB) - Get Report

slipped 2.99%, to 1,459 rupees, and

Icici Bank

(IBN) - Get Report

tumbled 3.45%, to 1,116 rupees.

After trading near 52-week lows earlier in the day,

Infosys Technologies

(INFY) - Get Report

closed up 1.16%, to 1,889 rupees, while

Wipro

(WIT) - Get Report

lost 0.07%, to 485.90 rupees.

But SBI's Shroff is bullish about the near-term outlook for domestic markets, and he said that foreign buying accounted for the Sensex lifting from its lows in early trading.

"The market was down about 1,000 points this morning, but now it's only down 300 points, so it recovered very sharply from those levels, and it was largely foreign buying pushing it up," he said in the early afternoon. "That shows the level of

international interest in the Indian stock market."

Still, the Indian plunge stopped China's rally in its tracks. After hitting new highs this week, the Shanghai Composite Index fell 0.92% to 6,032, and dipped intra-day below its new 6000 benchmark. After trading down throughout the day, the Hang Seng finished up 244 points, or 1.19% at 29,298.71.

Banking stocks in China were hit on the Indian news and uncertain profit-taking.

China Merchants Bank

lost 3% to 40.80 yuan, while

China CITIC Bank

fell 2.31% to 11.41 yuan.

In Shanghai,

China Life Insurance

(LFC) - Get Report

dived 3.9%, to 69.19 yuan, while in Hong Kong the stock gained 0.69% to close at HK$50.80. Reversing the recent trend of the mainland leading Hang Seng companies, major Hong Kong stocks

Petro China

(PTR) - Get Report

,

China Mobile

(CHL) - Get Report

and

China Unicom

(CN) - Get Report

gained 1.97% to 3.35%.

In Korea, the Kospi Composite Index was a victim of the Indian contagion, falling 22 points, or 1.09%, to 1.983.94. In Japan the Nikkei fared similarly, down 182 points, or 1.07%, to 16,995.31 as the carry trade continued to unwind. That's the Japanese index's first time below 17,000 since August. The yen was trading 116.30 vs. the dollar in Asia trading, but it is weakening again to 117.04 this morning.

Exporters such as

Sony

(SNE) - Get Report

,

Honda

(HMC) - Get Report

and

Canon

(CAJ) - Get Report

ended the day in the red, pulling the Topix down 24.96, or 1.8%, to 1,630.25.

The lack of control India has over its foreign investment, and the subsequent bearish contagion effect felt in China, renewed concerns by some that the recent gains in Asia stocks reflect a bubble that could burst at any time.

Sean Darby, head of strategy for Nomura Bank in Hong Kong, compared the scenario to the 1997 crisis in Thailand.

"Thailand faced a similar situation in December 2006 and resorted to direct capital inflow controls on overseas portfolio money," he wrote in a note to the bank's clients today. "The punitive measures introduced for foreign investors were rescinded within 24 hours of being implemented."

In other words, the restrictions in Indian derivatives trading today may be lifted as quickly as they were implemented; this would only exacerbate the scenario of so-called "hot" money in the markets.

Darby is bearish on MSCI India and MSCI China funds. Similar exchange-traded funds in the U.S. are

iShares:MSCI Emerging Market

(EEM) - Get Report

and

iShares:FTSE/Xinhua 25

(FXI) - Get Report

.

"The central bank in India is facing a potential problem of financial integrity if an external shock hits," he adds.

Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at

www.theglobalperspective.biz

. He lives in New York.