A fickle rupee and an increasing trade imbalance may not provoke an indifferent sentiment always. While the forex reserves have reached $355 billion, which is higher than the March level by almost $13 billion, a lot still depends on how our capital flows behave. While it is argued that we could be having a current account surplus any time with invisible flows being very positive, attention must turn to foreign investment, FDI and FPI, as it is normally assumed that we could get around $30-40 billion from each of these sources. At the same time, there is some reassurance that with the doing business environment improving significantly in the last year or so, there is hope that more funds would come in. The Make-in-India campaign is indirectly an invitation to investors to come and invest in the country. What exactly is the picture at the ground level?
On the whole, it is a mixed bag with several extraneous factors also working towards these flows. The Fed’s tapering programme followed by the expectations of a rate hike any time now has put these flows on the discussion table for both FDI and FII. While the former is normally associated with long-term commitment to any country, a pertinent question is whether or not these funds will get back to their homeland as the US economy recovers?
So far, FDI flows have been encouraging. In the first three months of the fiscal, there has been an increase from $7.2 billion in FY15 to $9.5 billion, though admittedly there is not much seasonal pattern here and these flows are dependent more on the current environment. In terms of the calendar year, the increase is from $15 billion to $19.4 billion. Assuming the same trend to be maintained, we could be expecting around $38-40 billion for the year, which is much on target.
Two issues which always come up when we talk of FDI in the current context pertain to taxation and our own mindset. Successive governments have been blowing hot and cold on tax laws, with the retrospective tax shadow always being an issue to watch out for. Any investor would like to have clarity on these issues as it is the basis of deploying capital. In the past it has been observed that investors do take into account the known impediments, like the difficulty in doing business in any country, as a known cost, but still do not hesitate to invest. But no one likes surprises.
The other is the recent Maggi controversy where there is already a sense in some foreign investors that there could be differential laws for foreign companies operating in India. With several countries clearing the same product, there is an impression that the due processes may not have been observed before the ban. Hence, while we strive to spread the message of Make-in-India, we need to be clear about such issues which could be irritants at the margin, but if left unchecked could colligate to become a deterrent for such investment.
The FPI scene also raises some policy issues for us. The debt inflows so far this fiscal till August 21 have been in the negative territory. The problem is structural. FPIs have a limit of $81 billion, of which $30 billion is in G-Secs and the balance $51 billion in corporate debt. Data presented by NSDL for August 24 shows that the two components of FPI in ‘G-Sec auctions’ and ‘G-Secs on tap’ have been fully exhausted. This means if we want to get more FPIs here, the limits need to be increased. The balance $23-25 billion are in corporate debt where there is a large balance, but also absence of interest.
The reason is simple. Until such time that the corporate debt market becomes liquid, it would be relatively unattractive for FPIs to invest here, as the exit route is very narrow. Considering that these funds are here to make money, the corporate bond market does not offer the same flexibility as does the G-Sec market. Therefore, we need to take a call here and probably shift some of these limits to the G-Sec segment. Are we prepared for that?
This scene also can be interpreted to mean that unless G-Sec limits are enhanced, India may not be at the receiving end in case the Fed increases interest rates at least on the debt side, as there is virtually no scope for higher investment under the current dispensation. Also, given that investors have fixed allocation for debt and equity, the switch to equity may not be forthcoming.
The equity picture also does not look too rosy. The first four months of the calendar year saw an upsurge in FPI equity flows of $7.7 billion. But since May, the flows have turned negative in three of the four months (till August 21), with net investment cumulating to negative $1.2 billion. Therefore, notwithstanding the Sensex swinging in a range of 27,000-28,000 during this period, FPIs have been net sellers in the market. The absence of clarity on the MAT retrospective that was spoken of by the government could have had some impact on these flows.
It is true that when currency markets are in a spin, there would be little order in all the flows as they search to cut losses in various markets which have repercussions on others. But in this wave of a run on currencies, the prudent thing would be to strengthen policies that inspire more foreign investment through both the routes so that we prepare the firm ground for these investors to come in when conditions stabilise.
It is clear that lower commodity prices due to weak growth proclivities in major markets helps us cut down our import bill, but also gets reflected in declining exports. The weak currency argument for augmenting exports works in a limited way, as they are driven more by demand-side forces. In such an environment, getting more foreign investment would work well for the balance of payments.
This becomes more important today, as we must remember that the 2013 crisis was tackled by getting in more NRI funds of above $30 billion. But all debt, which has crossed $475 billion in March, has to be serviced and probably returned to NRI deposit holders. Investment appears more attractive and hence the current crisis should lead to a fresh look taken on both FDI and FII flows.
The author is chief economist, CARE Ratings. Views are personal