With foreign institutional investors (FIIs) selling equities worth over Rs 8,688 crore in the last 16 trading sessions, the country is seeing the sharpest reversal in foreign capital inflows since the Lehman Brothers collapse 20 months back. Benchmark indices that advanced the most in more than two weeks on Monday, on the news of a possible patch-up between the Ambani brothers, failed to gain traction and closed flat on lack of FII support.
While macro-policy managers have put up a brave face, many analysts have begun to take note. It is feared that the 8.75% growth projection and a return to the fiscal consolidation path could remain elusive if the trend continues.
Analysts are sceptical of India retaining its status as an investment destination despite the euro zone crisis, the full effect of which is yet to be known. ?Our view is that if the European crisis deepens, and global markets suffer another leg down, it will get increasingly difficult for India to remain unaffected,? says Ridham Desai, head of research at global financial services firm Morgan Stanley.
In the quarter ended March 2010, FIIs held 14.5% in the BSE 500 stocks, making them the single largest investor class to decide the fate of the markets.
Last week?s outflows and build-up in short positions were strong enough to trigger the rupee?s sharpest weekly fall against the greenback since 1995, shows Bloomberg data. RBI?s foreign exchange has witnessed the sharpest fortnightly outflow in 16 months in the fortnight ended first week of May. The central bank had to take out nearly $3.4 billion from its then-$-280-billion forex reserves as money fled to safer havens. Money market players, who are busy reversing their long positions on the rupee, reckon that the outflow in the fortnight ended third week of May must have been way higher.
Senior analysts at credit rating agencies say India has much to lose if the outflows accelerate. The high deficit in India?s current account, which is funded primarily through overseas inflows, could be the first causality. The rupee?s sharp fall against the dollar, which usually results from heightened capital outflows, will make exports uncompetitive, nixing the half-blown recovery in this sector. An upward pressure on headline inflation that is staying shy of the double-digit territory will be another impact of the rupee fall.
This FII pullback could also impact the corporate houses? fundraising plans, throwing a spanner into the resurgent growth engine. Government-owned and private companies together plan to raise close to Rs 1.2 lakh crore in the next 10 months. In such a scenario, the situation could be all the more grave than the earlier slowdown as this time government does not have any fiscal headroom to announce boosters for the economy.
?India?s reserves comprise essentially borrowed resources and we are, therefore, more vulnerable to sudden stops and reversals compared with countries with current account surpluses,? RBI governor Duvvuri Subbarao said in Zurich last week.
?It is a worrisome picture if you put together India?s current account deficit and high fiscal deficit,? said Manoj Vohra of Economist Intelligence Unit.
Indian equity markets are reckoned to be high beta traditionally (Beta is the measure of an investment?s volatility relative to appropriate asset classes). They have so far warded off the danger of the euro zone crisis, better than many other global indices, prompting finance secretary Ashok Chawla and chief economic advisor at the finance ministry Kaushik Basu to state that unless there is a worsening of the crisis, it could only trigger higher flows into India. ?If the bailout package helps to contain the (Europe?s sovereign debt) crisis, we may get some additional capital inflows in search of a safer haven,? Basu told the media last week.