The unabated rise of Indian equity market is on. It touched a near 3 year high recently and is currently hovering around 20000 marks. The driver for this growth is FII flowing into India. Foreign investors have poured $7.1 billion into Indian capital market in August 2010, more than ever before for a month. With an economic growth rate of nearly 9% and a stock market that is more open to foreign investors than mainland China’s , India has become a destination of choice for financial investors. In the first nine months of the year, foreigners invested $28.5 billion in Indian stocks and bonds – more than twice what they invested in the comparable period of 2009.
In the recent years, with capital market reforms moving at brisk pace in India, the role of FII in Indian market has become crucial.FII hold around an average 12% share in BSE-500(Bombay Stock Exchange), which account for 93% of the market capitalization on the Bombay Stock Exchange. The increasingly dominant investors are FIIs, followed by domestic financial institutions and mutual funds. So it is clear that talks of decoupling for Indian market have simply lost their relevance.
The next question is what is driving FII into India? The answer lies in the wide gamut of external as well as internal factors. Though both the factors have seen extreme level of volatility, the internal factors have been quite stable for India and the testimony to this is the continuous inflow of FII in India and impressive return on investment offered by Indian bourses. External factors have been driver for emerging markets but they are mostly driven by global sentiments and so a cluster of parameters impact them.
India has been liberalizing its financial market but with much needed caution. The result is exemplary efficiency in trading and regulation contributing to the high growth in equity markets. Moreover, robust performance by the Indian Inc further fuels the appetite of the foreign investors.
The external factors of this gung ho are cheap money abroad and lack of other high growth options. Most believe that the flow will continue as investors seek more growth opportunities in equities, given the low interest rates, especially in developed market fixed-income securities. India’s robust economic growth indicators such as 8.5% estimated growth in GDP for fiscal 2011 and 20% estimated company earnings growth have also helped attract overseas money.
There are ample signs that external factors will remain positive for quite a sometime. Low interest rates and curb on foreign money in few emerging countries are likely to carry the momentum of FII for Indian markets. Even internal factors look to solidify the gains, as the forecast for 2011-12 is equally upbeat.
But there are spinoffs which are difficult to be ignored for quite a long. The biggest concern is the rise of Indian Rupee. The Indian rupee has appreciated about 4% (see the table) against the dollar so far this year and any further appreciation has the potential to damage Indian exports substantially. So either India has to look for a short term solution, which involves interference by RBI or a policy shift including a tax on FII. The problem is that such measures are unable to differentiate the short and long term investments. Moreover, with the kind of volatility FII inflow possess, such moves can be disastrous. Also, the normal exit period for FII is considered to be December, so any curb now can actually be counter-productive. The stand taken by government vindicates this situation and quite vividly expresses the fact that Indian Economy is looking for a never seen expansion.
Whatever be the case, the Indian companies have been benefitted by this glut of fund. The strength of the market has been a boon for Indian companies, as well as the Indian government, which has been selling shares in state-owned firms. The fact that Coal India’s IPO has been oversubscribed 15 times clearly vindicates this argument.
So it is clear that while India bourses cannot be assumed to be decoupled from global markets, the flow of FII is the game changer. Clearly the conundrum is the optimum level of FII for Indian capital market. Irrespective of all these, the big reality is that emerging markets have to adjust to this huge inflow.
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