The Hindu Business Line : The tipping factor

Foreign exchange reserves currently running in excess of $150 billion can lull one into a sense of complacency about the stability of the exchange rate. But it would be a folly to ignore the fact that the reserves have been built largely with the flow of portfolio investment in the stock market. India's external obligation on account of investments by foreign institutional investors stands at $63 billion. True, this does not represent any commitment by some Indian entity to repay an equivalent amount should these investors seek to take their money out. Equally, this does not also imply any commitment on the part of the Reserve Bank of India to make foreign exchange available to the investor at the time of repatriation. But any sudden outflow of such monies can cause huge gyrations in the external value of the rupee.

The market value of the FII portfolio is a better barometer of its potential for triggering volatility in the stock market rather than its historical cost. Though neither the RBI nor SEBI furnishes actual information on this, a rough estimate based on net inflows and movement in the stock market indices over time clearly suggests that the current market value could be in the region of $130 billion. The market capitalisation of listed stocks at the BSE is currently around $550 billion and the promoter stake, even at a conservative estimate of 30 per cent, means that FII holdings as a percentage of `free-float' of traded stocks can be so large that not only their actual actions but even perceptions of prospective behaviour can cause huge variations in equity values, often to the detriment of small retail investors. The events of May 2006 clearly demonstrated that: a small net outflow of approximately half a billion dollars caused a 20 per cent decline in equity values in one month. FIIs are increasingly churning their portfolios, thus adding to the volatility. For instance, in the first quarter of the current fiscal, FIIs sold stocks and repatriated $31.3 billion, or 56 percentage of the net outstanding portfolio investment as of June 30, 2006, even as they brought in $30.8 billion.

From a position of being just marginal players and often reduced to chafing at the poor trading conditions, as was their plight back in the early 1990s, when the market was first opened up for investments, they have grown in stature, owning significant chunks of pivotal stocks in the country. Any curbs on their inflows or imposing entry or exit loads on FII flows, as has been suggested in some quarters, needs to be carefully thought out. But in the interim, what the RBI and SEBI can collectively do is to increase the scope and frequency of disclosure of relevant information about their investment operations.

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