How Foreign Direct Investment inflows fare over the year will be critical

By: |
October 3, 2020 6:32 AM

Performance of capital flows has been worse only during the global financial crisis and the taper tantrum of 2013

Net FDI flows came in at a negative $0.4 billion compared with a rise of $14 billion a year ago and $12 billion in the March quarter.Net FDI flows came in at a negative $0.4 billion compared with a rise of $14 billion a year ago and $12 billion in the March quarter.

The rather sharp sequential deterioration in the capital account to $0.6 billion in the June quarter, from $17.4 billion in Q4FY20, was the result of virtually all categories of capital flows being subdued, but most of all the fall in net Foreign Direct Investment (FDI) flows. Net FDI flows came in at a negative $0.4 billion compared with a rise of $14 billion a year ago and $12 billion in the March quarter. Only during the time of the global financial meltdown and the taper tantrum in 2013, has the performance of capital flows been worse. However, it would be too early to raise any alarms because the gross FDI flows were reasonably robust at $11 billion. Indeed, given the June quarter was a particularly stressful time globally, investments should be a bounce-back in the coming quarters. It would not be far-fetched to pencil in close to $30 billion for the year compared with $43 billion in FY20 given July notched up a strong $3.3 billion.

However, foreign (FPI) portfolio flows have been weak for two consecutive quarters now; following outflows of $13.7 billion in Q4FY20 when the emerging markets saw a sell-off, the June quarter reported just $0.6 billion. With central banks in accommodative mode and global liquidity surpluses abundant, FPI flows have no doubt recovered to about $6.6 billion in the July-September period. However, FPI flows tend to be fickle and one can’t ignore the September outflows from the equities portfolio. While ample global liquidity should see India attract a net $5-6 billion in FY21, compared with $1.5 billion last year, how much risk appetite FPIs have for Indian stocks and bonds remains to be seen. One doesn’t also know how the trend in foreign loans is going to play out; against quarterly inflows of $5-6 billion last year, the June quarter saw an outflow of $1.6 billion.

The current account surplus of $19.8 billion or 3.9% of GDP was more or less expected since the trade deficit had shrunk to a negative $10 billion. With the global unlocking coming along, one can expect some pick-up in global trade and consequently in India’s exports. While exports may not cross $290 billion this year that would be a relatively good showing at a time when the global economy is reeling under a demand shock, and the WTO estimates world trade will contract 13%-32% in 2020. With the local economy sluggish, it wasn’t a surprise that non-oil imports accounted for 65% of the decline in the trade deficit in Q1. With crude oil prices expected to remain in the range of $40-43 per barrel and growth expected to accelerate only modestly in H2, the import bill for FY21 is unlikely to exceed $410 billion.

The good news is that the services surplus shrank only slightly to $20.5 billion versus $22 billion in Q4FY20, much less than anticipated, despite the income repatriation increasing 23%. This reflects the strength of the IT services where the earnings fell just 1%. Again, net remittances remained relatively strong at $17 billion contrary to expectations. However, since crude oil prices are not expected to rise meaningfully, so as to revive the Gulf economies, remittances could slow further as more workers return home. Unless there is a strong revival in the home economy that pushes up non-oil, non-gold imports, the current account is expected to remain flat or report a slight surplus for the year.

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