Foreign institutional investors have pumped in over a billion dollars worth of net investment into the Indian stock market in December, taking net inflows this calendar year to well over $7 billion. Nor has India been the only beneficiary of this largesse.

According to one research house, investors across the world have pumped in a record $11.2 billion into emerging market equity funds this year, well above the previous record of $10.89 billion set in 1996.

Asia, ex-Japan, equity funds received $6.3 billion, nearly double their previous 1996 record. There are several reasons for this rush of money into emerging markets in general and Asia in particular, reasons that could give some clues into whether these inflows will continue.

First, 2003 has been a year of revival in world markets, with the MSCI World Index up 27 per cent in the year to December 19.

But emerging markets have done much better (the MSCI Emerging Markets Free index has risen 46 per cent) because they had been beaten down earlier, and Asian markets in particular have suffered due to the Sars epidemic.

In India, last year's drought had taken its toll. The upshot was that stock valuations in Asia were low. At the same time, central banks across the world relaxed monetary policy in an attempt to resuscitate their economies.

Interest rates fell to record lows, leading to a huge increase in consumer debt. This flood of money had to be invested somewhere, and emerging markets as an asset class were priced cheaply.

To be sure, Indian companies have improved their competitiveness substantially, but this has been an incremental process over several years, and it was the global surplus of liquidity rather than the "fundamentals" that led to the runaway rise in share prices.

The other important feature of the global economy is its dependence on the US as its engine of growth, although this has been complemented somewhat in recent times by China.

The dependence of the rest of the world on US consumption has led to a staggering current account deficit in the US, a deficit that has to be financed by foreigners buying US assets.

This fundamental weakness can only be addressed either by the rest of the world increasing domestic demand or by a decline in the value of the dollar. Needless to add, the falling dollar adds to returns from emerging markets.

The current environment should continue so long as US interest rates are not raised, which in turn will help stabilise the dollar.

And since the Federal Reserve has let it be known that it is in no hurry to raise interest rates, the party could continue for quite some time.

To be sure, there will be continuous re-allocation between asset classes as their relative valuations change, but the India story has been sold well, and anecdotal evidence suggests that the appetite for Indian paper continues to be strong.

Note also that FII flows hold the key not only to the Indian equity markets, but to the debt markets as well, thanks to the liquidity generated by the sterilisation policy of the Reserve Bank.