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. Last Updated: 07/27/2016

Indian Curbs May Help Russia

Emerging-market investors got a sharp sense of deja vu last week as India's financial regulators took measures to restrict foreign investment, prompting speculation that markets in Moscow could make up lost ground as investors take another look at the Russian story.

The Indian stock exchange plummeted -- dropping 9 percent in a matter of minutes Wednesday, to recover later -- after the country's Securities and Exchange Board proposed to stop issuing derivative notes. These notes enable offshore investors, particularly hedge funds, to invest in Indian equities without buying in directly, while they also do not have to register with the board.

The announcement sent the closed-end India Fund tumbling down 8.5 percent Wednesday while the Morgan Stanley India Investment Fund was down 6.5 percent.

Some analysts said India's protectionist move could be the much-anticipated trigger that will bring momentum back to the Russian markets.

Over the past year, Russia's markets have significantly underperformed those in the other BRIC economies, and analysts say the country stands to gain from the India's turmoil if investors decide to look elsewhere.

"India's move to restrict the inflow of foreign investment may finally provide the much-needed trigger, letting Russia benefit from India-destined cash," said Chris Weafer, chief strategist at UralSib.

"This year, investors have been ignoring Russia and the fund flow has been a modest $10 million or $20 million a week, whereas China, India and Brazil have been taking in billions of dollars."

Over the last four weeks, India has seen an inflow of $700 million, while Brazil has enjoyed inflows of $3.3 billion.

Compare that to Russia, which has seen portfolio investment reach just $200 million during the same period, according to data from the Emerging Portfolio Fund Research.

"When the Indian financial market nose-dived Wednesday, the only conclusion was that investors could take their money out of India and put it into Russia," said Erik DePoy, a strategist at Alfa Bank.

Georgy Ivanin, chief strategist at the Antanta Investment Fund, pointed out that the structure of Russia and India's financial markets was very similar, meaning that in the case of investor restrictions in India, Russia "is probably the next port of call."

But some analysts were more cautious about the prospects that funds would switch their focus more to Russia.

While foreign money may face restrictions in India, it is not a given that Russia will be the market to benefit.

Vladimir Kuznetsov, director of equity investment at Finam brokerage, said Russia needed an overhaul of its business climate and investment regulations if it is to lure investors away from the other BRIC markets.

"Every investor has his own vision of the country in which it has to invest and to many, Russia is considered a high political risk area," Kuznetsov said.

"That is why the Russian government created a special agency to work on the country's image abroad. The need for positive information about the Russian economy and stock market is very acute."

Investors say much of the money flowing into India has been so-called "hot money" from hedge funds.

Much of it is speculative, and India's market regulators have taken the view that this money is a contributing factor to the country's overheating economy.

Eric Kraus, managing director of the Nikitsky Fund, said that Russia was suffering from the much the same problem as India, in that both countries are experiencing excessive capital inflow.

The majority of companies in both India and Russia have a single reference shareholder and the free float is inadequate, he said.

The last thing Russia needs, Kraus said, is speculative foreign investment.

High energy prices over the last two to three years have brought windfalls to the country, creating a huge buffer of domestic capital, Kraus said.

"Russia has to avoid the inflow of hot money -- this is a problem for India right now and could be a problem for Russia. The country needs long-term capital commitments," Kraus said.

Russia's two indexes -- which have enjoyed a remarkable recovery in recent weeks -- dipped toward the end of last week on the back of concerns about rising inflation and the government's statements that it would intervene to cap consumer prices.

The benchmark RTS index fell 0.95 percent to finish the week at 2142.42 points, while MICEX dropped 1.84 percent to 1801.42 points.

Staff Writer Catrina Stewart contributed to this report.