Will FIIs continue to woo Indian markets?

The Economic Times TUESDAY, JULY 06, 2004

SANDEEP DASGUPTA, CEO, Deutsche Asset Management (India) Pvt Ltd

In the year 2003, India became the darling of FIIs. The FII flows depend on a couple of issues; primarily on global trends and local fundamentals. As long as the government continues to offer higher-growth-oriented policies for the long term we would continue to see inflows. Investors will be keenly watching the pace of deficit reduction, privatisation and tax reforms, including plans to introduce a value added tax. If the government can reassure the investors that it is committed to reforms in the areas of duty rationalisation, infrastructure creation, opening up of new sectors for investment, and relatively better labour policies I expect that India will continue to be an attractive destination for FII investments.

The other factor that will play an important role in attracting FII flows is the continuation of domestic demand. While the demographics of the Indian subcontinent has been the biggest strength in boosting demand and generating employment, the government has to work earnestly to create over 10 million jobs every year to maintain 8% plus growth in the economy.

Lastly I would like to add that FDI and FII are not independent. Policy makers ought to appreciate the progressive role of foreign investment in the country. China has shown that FDI, besides boosting exports, can help improve the lot of a number of local firms. India needs to learn from this experience. We believe that the government will have to take initiatives to attract more FDI. This can be done by opening up more and more profitable sectors to foreign investors as also by allowing them to play a larger role. We will have to get out of the mindset of restricting their role to just silent investors and let them have some management control.

S V PRASAD, Chief Executive Officer, Birla SunLife AMC Ltd

Interest rates have gone up in the United States and are expected to go up further. The 10-year government paper in the US currently trades at around 4.5%, with the differential vis-a-vis the Indian 10-year government securities being around 1.20%. If you take the average inflation rate in the two economies it is very evident that the real rate of return in the US is higher than in India. Consequently, we’ve witnessed an outflow of money from India. This could further aggravate in the near future.

Further, the US economy is back on a growth phase and employment numbers are looking up. These in turn have raised concerns of inflation in the United States. Such apprehensions have been further compounded by the growing concern on the price of crude oil, followed by the planned cooling of the Chinese economy. As a result, the MSCI Emerging Markets Free Index has lost 6.45% year-to-date, while the developed countries index has gained 1.23%. However, emerging market economies will continue to outpace developed markets in terms of real GDP growth, making them relatively attractive in the medium- to long-term. India is likely to register a GDP growth of 7-8 % in FY 05.

There is little doubt that incremental growth and productivity will be higher in India and other emerging markets. So a sustained in crease in the FII flows is a distinct possibility in the medium to long term. Net private capital flows to emerging market economies are likely to grow to $225 billion in 2004, an increase of over 15% from $194 billion in 2003 ($128 billion in 2002). The Asia-Pacific region is expected to rope in almost 50% of total flows to emerging markets. In the Asia-Pacific emerging markets, India is expected to garner $7 billion on the back of rising corporate profits and improving prospects of economic growth.

The growth story in India is a domestic one, and not dependent so much on external economies. In the calendar year 2004, FIIs have already poured in $4.12 billion into the capital market in just three-and-a-half months, of which $3.76 billion has been invested in equity and a mere $359 million in debt. This is nearly 54% of the total investment of $7.6 billion and half of the total investment made by them in calendar year 2003. (This data is as of April 20, 2004.) The India Story, in terms of rising exports of services, and engineering, auto, auto components and generic pharmaceuticals are on track and we are likely to see a robust growth in exports over the next three to four years. Therefore, the balance of payments situation is likely to put pressure on the US dollar, which in turn is likely to strengthen the in the medium run. Currency stability will be the biggest positive factor for FDIs and investment by FIIs.

ANOOP BHASKAR, Fund Manager (Equity), Sundaram Mutual

Before taking a view on FII flows into India during 2004, a broader picture of fund flows into the emerging market will help us give a more holistic answer to the above issue. As per the latest report of the Institute of International Finance (IIF), a global association of financial services companies, net private capital inflows into emerging markets — FDI as well as portfolio investment — are expected to grow from $195 billion to $225 billion. This will be the highest level achieved ever since the Asian crisis of 1997-98. Roughly $25 billion (as against $21 billion in the previous year) will be net portfolio inflows into emerging markets across the world.

Importantly, almost 95% of this would be directed towards Asia. Thus, the overall flows into emerging markets will be sustained after touching record levels in the previous year. These flows are being driven by higher allocation from large institutional investors, especially pension funds like Calpers, whose investment destination earlier had been limited to the developed markets. In addition, most money managers, especially in the US, have again started to increase their allocation towards the emerging markets after having withdrawn, after the Asian crisis of 1997-98.

While FII flows of 2003 — US$7 billion — may appear to have topped the trend of FII flows into India, a definite upward trend is clearly discernible even now. Pre-FY 2004, the average inflow of FII was in the region of $1.5-2.0 billion a year. During the first six months of the current year, FII inflows have already crossed the $3.5-billion mark. The number of FIIs registered with Sebi has increased significantly over the last year. A large part of these new registrations are from pension funds, whose investment horizon is much longer compared to a hedge fund.

Thus, even though FII inflows will be lower than the record level of the previous year, they would be much higher than the average received in the past. In addition, most influential brokerage houses have placed India as an “overweight” in their model portfolio for Asian/emerging markets.

Finally, as the investment guru Marc Faber has pointed out “Asia will be the economic hotspot for the next 50 years”. India and China have prominently figured in the famous ‘BRICS 2050’ report by Goldman Sachs. For an equity investor with a time horizon of 5-10 years, India as market to ignore would mean sustained, long-term underperformance. While FII flows may slow down in the current fiscal, the upward trend is undeniable. Thus, the question “Why India?”, which was asked by fund managers, a few years ago, has been replaced by “How much in India?”