Conventional wisdom has it it, if economy is growing and corporate fundamentals are strong, investing public would getting attracted especially towards stocks of companies doing well and those who are partners in growth story.
During last 4 years since 2010, Indian economy has been on a downward trajectory with GDP growth showing a decelerating trend to 6.2% in 2011-12; 5% during 2012-13 and further down to 4.4% & 4.8% during first and second quarter of 2013-14.
Yet, acting in a contrarian mode, foreign investors have shown extraordinary interest in Indian stocks and resorted to aggressive buying spree. During 4 years ending December 2013, they have pumped around Rs 370,000 crores (US$ 60 billion).
This is more than combined investment in 9 years beginning 2001 and dwarfs all that was invested during boom years of 2005-08. In the past 4 years (with the exception of 2011), foreign institutional investors (FIIs) have invested about US$ 20 billion each year.
As a consequence, ownership of FIIs in Indian stocks has reached new highs. The aggregate holding of offshore funds in benchmark Nifty companies was hovering around 18% in the first three quarters of current fiscal year.
Foreign investment in companies such as NTPC, Tata Power, WIPRO, HCL Technologies, Sun Pharma, Axis Bank and M&M has increased substantially. FII holding in some of country’s biggest blue chips is in excess of 50% viz., HDFC (73%), ICICI Bank (67%) and Infosys (about 55%).
Why have foreign investors come in droves despite weak economic fundamentals? Why have Indian investors especially domestic institutions not acted similarly? How does one resolve the dilemma between rising sensex and a sluggish economy?
While arriving at a decision, an investor is governed by his assessment of return that he hopes to make. However, for institutional investors, ‘strategic’ factors also play an important role. FIIs do take a long-term view to be partner in the development process. Availability of funds is also major consideration.
Now, if FIIs have invested heavily ignoring decelerating growth and diminished corporate earnings, it is clear that they have a long-term perspective. They perceive that notwithstanding temporary set-back, long-term Indian growth story remains in tact.
Global rating agencies have pointed to ‘stable’ and ‘decisive’ Government post-general elections in April, 2014. They expect an end to policy paralysis that marked last couple of years under UPA-II and fast decisions under a new dispensation led by Mr Narendra Modi, the prime ministerial candidate of BJP.
If, such a scenario unfolds, India can have real good governance and implementation of reform measures on a fast pace. That can help resurrection of growth on to a fast trajectory. FII would have factored this while deciding on their investments.
Another crucial factor is the virtual flood of dollars due to implementation by US Fed bank of what is euphemistically described as ‘Quantitative Easing’ (QE) since 2010 – an un-conventional monetary policy – aimed at mitigating the deflationary effects of financial crisis in 2008.
Since, interest rate in USA had already touched rock bottom and it was just not possible to prop up demand through this conventional monetary policy instrument, Fed bank went for the un-conventional route. Under QE (implemented in 3 rounds), it pumped billions of dollars each month through purchase of Government bonds.
Under QE 3 – that started in December 2012 – the US central bank has been pumping US$ 85 billion per month. Recently, Federal Open Market Committee (FOMC) decided to scale down (so called ‘tapering’) from January, 2014, yet the release of dollars will continue to be substantial at US$ 75 billion per month.
Cumulatively, the balance sheet of Fed bank has bloated to around US$ 3.5 trillion (1 trillion = 1000 billion) (this incidentally is 75% more than size of Indian economy at around US$ 2 trillion). Even as this money was intended to boost US economy, a substantial chunk has moved out mostly to emerging market economies (EMEs).
Clearly, stimulus from QE has also contributed substantially to inflow of foreign funds to India. One can easily discern perfect synchronization between QE program and huge FII investment. The strong linkage may be seen from another angle.
In May, 2013 when Fed Bank gave an indication of a drastic wind down of QE 3, that led to a panic and within 3 months around US$ 12 billion of FII funds moved out. This was stemmed in September when new Governor, RBI took some innovative steps and more so, in October, 2013 with FOMC mooting a ‘gradual’ scale down.
In short, two key propellants to foreign investment were deep pockets of FIIs – helped by QE – and their conviction in India’s long-term high growth story. On the other hand, domestic financial institutions (DFIs) have been hamstrung by shortage of funds and lacking vision about future growth prospects.
Another reason as to why domestic investment has been mute is sheer un-willingness of those who control the huge pool of pension & provident funds (primarily the political class and unions) to let these funds be invested in equity markets. This is despite Government encouraging them by necessary changes in investment norms.
Clearly, during the turn-around period that may arrive quickly in case a ‘stable’ and ‘decisive’ Government takes charge post-general elections, FIIs would be the prime beneficiaries in view of their substantial ownership in Indian corporate especially blue chip.
A closer look on manner acquisition of Indian assets by foreign players has been funded brings out an un-healthy dimension. The deluge of dollars – courtesy QE – provided them easy access to what we may term as ‘phoney money’. Meanwhile, DFIs have been clearly at a disadvantage as funds in their kitty are far more costly!
Mandarins in the Finance Ministry and Mint street might be pretty pleased with the way funds brought in by FIIs helped in addressing India’s CAD woes. However, they must not be oblivious of ‘vulnerabilities’ associated with their substantial share in stock of Indian corporate.
Apart from regular outflow of funds by way of dividends and other means, economy can be exposed to a severe & sudden jolt in the event of FIIs resorting to aggressive off-loading of stocks. The erosion in value of stock held by DFIs, retail investors etc can be hugely de-stabilizing!
Government can help restore a semblance of balance by creating a conducive environment for DFIs as also retail investors to put in their money in Indian stock.
It should come up with innovative steps to enable flow of long-term funds viz., pension, provident etc to the capital markets. If, foreign funds can earn good returns from Indian market, why can’t our own funds do?
A majority ownership by domestic players will ensure that benefits of high growth remain in India and economy is shielded from external shocks.