Much ado about FII flows

T T RAM MOHAN

The Economic Times THURSDAY, OCTOBER 07, 2004

The popular perception that international investors create instability in emerging markets is not borne out by studies on the investment pattern of US mutual funds. The studies suggest that neither shareholders nor portfolio managers behaved in a manner that could exacerbate volatility in emerging markets. Redemptions by shareholders tended to be modest. And portfolio managers did not reallocate assets in ways that could have caused prices to plummet. A remarkable finding of the East Asian crisis was how stable portfolio investment was during the period; the mischief was created entirely by debt outflows. In India itself, over a decade of twists and turns in economic policy, FII flows have been negative only in one year.

• One reason could be that pulling out funds would be prohibitively costly for portfolio investors. Investors face a double whammy in exiting a market: a fall in stock prices and a steep depreciation in currency.
• Secondly, investment in emerging markets is dictated by the principles of portfolio diversification. Once an optimal portfolio has been arrived at based on long-term data, it would not make sense to exit a market unless the risk-return profile of the market was perceived to have changed drastically.
• Thirdly, emerging markets account for just around 14% of total assets of international investors; Asia’s share is 9%; India’s is probably under 1%. For dedicated emerging market or country funds, it may make sense to track policy pronouncements closely. Not so for what are called “crossover” investors — investors for whom a given emerging market is just one of a number of assets in the portfolio.

So, here is a message for TV pundits. The next time you are asked how FIIs would react to a ‘no’ to privatisation of airports or an increase in the FDI limit for telecom, please could we see some sanity in your responses? (The author is a professor at IIM, Ahmedabad)