managing fiis inflows--.rks.doc

8/20/2019 Managing FIIs inflows--.RKS.doc

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K.K.Verma(ed)Management Perspectives in New Millennium(New Delhi:

Dilpreet Publishing House) !""#pp. "$"!.

M%N%&'N& ''s 'N*+, 'N-* 'ND'%: ,*M

*P-'*N,

R.K.Srivastava*%bstract: Being on the most attractive emerging economy, India has attracted a large chunk of portfolio funds. A number of reasons including Indias gro!th story, interest rate differentials bet!een emerging and developed economies, etc have been cited to "IIs inflo!s into India. At agiven point of time the economy has the capacity to absorb only a given amount of capital.

#apital inflo!s in e$cess of that can create problems. %o!ever, there are some options availablein the hands of &overnment and RBI to manage this situation prudently.

Ke/ words: "oreign Institutional Investors'"IIs(, "oreign )irect Investment'")I(, capitalinflo!s, financial integration, emerging economies, gro!th story, appreciation, depreciation,liuidity, #ash reserve ratio'#RR(, +obin ta$, participatory notes'-s(, stimulus packages.

'. 'N-0*D12-'*N

"oreign Institutional Investors '"IIs( investment can take place in a variety of !ays likein shares and bonds long/term fore$ loans and short/term fore$ loans. +he beneficialeffects of "IIs are some!hat indirect and not as visible in the case of ")I. "II inflo!s too

help capital formation either by participating in public offerings or by releasing thee$isting pool of risk capital through secondary markets. +here is a general fear that "IIscan reverse at any time 'Srivastava, 0112(. +herefore, portfolio investment is called hotmoney.+he linkages that "IIs provide have their pros and cons. +hey have brought heterogeneityto the Indian markets 'as "IIs come in all colors and shapes(, improved governanceuality and made the markets more efficient. But the do!n/side is that they link India toglobal markets and bring some of the riskier global practices into the Indian markets asIndia is e$periencing currently. In the meantime, India increasingly has integrated !ithglobal markets 'Shah, 0113(. %o!ever, the strong increase in net private capital inflo!sto the emerging market economies over the past fe! years is proving to be a mi$ed

blessing. Although these flo!s help deliver the benefits of increased financial integration,they also create challenges for policymakers because they can lead to over heating, a lossof competitiveness and increased vulnerability to crisis. 4hile a number of studies havee$amined the policy responses to capital inflo!s in the 5661s, focusing on a limitednumber of country cases, there have been fe!er studies involving recent episodes of capital flo!s and even fe!er attempts to systematically compare ho! different countrieshave responded in terms of ne! policies ' #ardarelli, 0117(.

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Being on the most attractive emerging economy at present, India has attracted a largechunk of portfolio funds. +he ma8or issues and concerns are '+he 9conomic +imes,56.55.16(:

• India runs a large trade deficit because of the huge oil imports. +he country also

needs foreign capital to step/up investments

• In that sense foreign capital inflo!s are vital to the economy

• %o!ever, at a given point of time the economy has the capacity to absorb only a

given amount of capital

• #apital inflo!s in e$cess of that can create problems.

India has already attracted portfolio inflo!s of over ;5< billion in 0116 calendar year sofar against ;01 billion in 0117. ")I in April/September 0116 !as ;57.7= billion against;>2.0 billion in 0117/13. ?ver rising capital inflo!s into India, it looks it imperative inshort/term as !ell as in medium @term that a far/reaching implications may take place inthe Indian economy. +herefore, the main ob8ective of the paper is to identify the options!hat India can take to manage the situation.$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$

*rof. of 9conomics,%-B &arh!al niversity ,#ampus Badshahithaul, +ehri '&arh!al (

''.-0ND,

India has been a key beneficiary of the improvement in sentiments to!ards emergingmarkets and this is reflected in the large "II inflo!s in 0116. "IIs presence in the Indianmarkets is deep rooted !hich has emerged the follo!ing trends:(i) 3ear$wise: -et purchases of the Indian shares by "IIs have topped the ;5< billion

mark for current calendar year '0116( and market !atchers say a depreciating dollar could drive more money into emerging markets like India in the near term, as globalinvestors try to ma$imie returns. In 0117, foreign funds net pumped in a record ;01 billion in Indian shares '+he 9conomic +imes, 57.55.16(.+he large scale foreign portfoliofunds have flo!ed into emerging markets because of flood of liuidity in the globalmarkets. +able5 sho!s that foreign investors have given !eight age to the Indianmarkets by deploying more funds.

+able 5: "II inflo!s into India

Cear Amount';billion(

011< 6.11

0117 01.11

0113 /6.><

0116 5


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'ii) ,ector$wise: "II holdings are 02.1, 0116. +heir

e$posure in capital goods sector fell to 6.6D from 50.5D and to 52.5D from53.2 in retail

space. +able 0 sho!s that "IIs have re/balanced their holdings among sectors in India.

+able0: "II holdings as D of combined euity of all #ompanies in each sector

Sector Sept.0116 Sept.0116 Sept.0117

Agrochemicals 02.< 0>.< 01.2

Real 9state 02.= 6.< 51.>

Bre!eries 53.< 05.5 00.7

Eining 57.6 53.1 01.7

Banks 5.> 50.3 50.7

#ement 5>.0 5=.1 57.0

Info+ech 50.5 52.< 52.7

Automobiles 51.7 51.= 5>.1

#apital goods 6.6 50.5 50.0

'iii) 2ompan/$wise: "IIs holding and share price movement have a strong positive

correlation. Stock prices of companies !here "IIs increased their holding in September

uarter16 rose >0D on an aggregate during the period. Shares of companies, !here "IIs

holding remained the same and declined, appreciated 53D and 50.0<

Remained same 57.32

)eclined 5


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Returns bet!een Gune >1 and Sept >1,0116Source: #EI9 )atabase

+op five companies, !hich attracted "IIs the most, are %)IF, Sobha )evelopers,

%industan #onstruction #ompany '%##(, Indiabulls "inancial Services and ?rbit

#orporation. Eost of these companies are engaged in construction and infrastructure

related !orks !hich suffered the !orst during the credit crisis. In %)IF, foreign holdings

rose to 0


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emerging and developed economies is one of the most important factor has compounded

the capital surge in emerging Asian countries including India, as returns from such flo!s

have become more attractive. #learly, the cost to borro! dollar is lo!er than to investing

in emerging economies. "or e$ample, FIB?R rates are at >D and emerging markets bond

spreadsHthe differential bet!een government bond yield and corporate bond yieldsHare

do!n from 311 bps at the peak, to >11bps. So, in essence, the emerging market risk is

coming do!n !hich is a comfort one for a foreign fund management to increase

e$posure to emerging markets.

Interest rate differentials in the !orld markets, already favoring emerging markets and so

attracting investment flo!s, are set to e$pand further. +he conseuent impact on fore$

market is that rupee has appreciated. "or instance, rupee has appreciated about 50D from

early Earch 0113, making e$ports less competitive. 9$ports, !hich make about one/fifth

of Indias &), have been falling since ?ctober 0113. "or the e$port/led companies,

rupee appreciation may be bad phenomenon. +hus, it affects the fortunes of these

companies.

Eore importantly, the S, the euro one, Gapan and Britain are sho!ing no inclination to

push up their rates anytime soon as recovery proves slo!. Rising inflo!s have helped

drive up stock and property prices in India promoting the RBI to increase provisioning

reuirements for loans to real estate companies to asset bubbles. +he RBI is already

!orried about inflation but has limited monetary tools to tame price rises. +he RBI has

said there is a risk that if it raised interest rates ahead of other #entral Banks, it could

attract more inflo!s and complicate policy making.

'V. *P-'*N,

A large chunk of high fore$ inflo!s particularly through the "II route have been posing a

challenge to the RBI. If capital inflo!s continue to maintain their current momentum, the

policy makers !ill have to initiate some more capital control measures. +he options in the

hands of RBI are:

(i) RBI does not !ant to leave such large capital inflo!s fueling the domestic

liuidity !hich create inflationary pressures in the economy. +herefore, RBI is

forced to suck e$cess liuidity in the system through issues of bonds to

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control money supply and check inflation. +his is called steriliation, but it

pushes up interest rates !hich !ill increase governments borro!ings costs.

Raising the cash reserve ratio '#RR(, it could also discourage capacity of

bank lending.

(ii) +he government should have improved absorption of liuidity arising on

account of large capital inflo!s. It should increase infrastructure sector

investments either through increasing budgetary allocation andor encouraging

the private sector to accelerate investments in this area by improving the

regulatory environment.

(iii) It is advocated that some sort of +obin ta$ on foreign capital flo!s is

desirable. Games +obin, -obel rie !inning economist, had proposed this ta$

on fore$ flo!s in 5675. )uring the 5667 Asian crisis, Ealaysia had

successfully e$perimented to it. Recently, Brailian government has imposed

a 0D ta$ on all foreign e$change inflo!s. But in India in some uarters it is

considered as retrograde and impractical step.

(iv) &overnment can restrict articipatory -otes '-s( in the Indian markets. -s

are derivative instruments !hose underlying securities are Indian stocks.

+hese are issued by "IIs to overseas investors !ho !ant to invest in Indian

stocks but are not allo!ed to do so 'Srivastava, 011


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RBI should be hiking interest rates but cannot do so unilaterally at this

stage at that could cause even larger capital inflo!s

RBI left key interest rates unchanged in its ?ctober 07,0116 revie! of

monetary policy

V. 2*N21,'*N

+he free flo! of capital is the life/blood of sustainable economic gro!th and e$panding

prosperity. "IIs inflo!s are an attractive device !hich assists to globalie the domestic

companies. But its pitfalls are also !ell kno!n, any time portfolio money can fly into

another destination. It has been seen in the !orld economic crisis 0117 and 0113 !hen

portfolio investments had been pulled back suddenly in large scale from stock e$changes.

+heir affects !ere havoc in capital markets. Again "IIs are more active in emerging

economies since April 0116 and are pumping more money in these markets including

India. A number of associated problems of large scale "IIs inflo!s into India are:

• Sharp increase in money supply

• Inflation

• Eonetary management become difficult, interest rates !ould have to be hiked,

affecting recovery

• Rupee !ould tend to appreciate, making e$ports less competitive as rupee income

of e$porters from the same amount of dollars !ill fall.

Indias gro!th story is the prime reason to "IIs inflo!s into it in the large proportion. It is

primarily driven by domestic consumption !hich looks to the global investors more

convincing and stable. India is considered as a land of opportunities therefore,

international community cannot !ant to miss it. Stimulus packages, provided by the

governments, have created ample liuidity in the markets. It is being deployed by foreign

investors in stock and commodity markets in emerging economies including India. +o

avoid the repercussion of the e$cess "II inflo!s into India, a number of conventional and

non/conventional measures have been suggested to cut the ice.

Reference:

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JBreathing easy for no!, but &ovt. may choke Inflo! if need be +he 9conomic +imes,

56.55.0116.

#ardarelli, Roberto, et al, Fearning ho! to cope !ith big #apital Inflo!s, IE"

Survey,-ov.0117.

J"II Shopping bring at ;52 B and #ounting +he 9conomic +imes, 57.55.0116.

J%igh "II holdings are key to Stock price rise +he 9conomic +imes, 5.55.0116.

Roach, Stephen, +he Indian &ro!th Story is more #ompelling, +he 9conomic +imes,

0.55.0116.

Shah, Ra8esh, 0113, #an )omestic layers support Stock EarketL +he 9conomic

+imes,03.51.0116.

Srivastava, R.K., 0112, "II inflo!s into India: A )ilemma, IBA Bulletin, Guly 0112.

Srivastava, R.K.,011

managing fiis inflows--.rks.doc

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