FII flows saw record levels of $28 billion plus in 2010, the highest since we opened our markets in 1993. This was on the back of attractive valuations and the strengthening growth story with strong corporate earnings growth. Companies catering to the ever-rising middle class have seen large portfolio investments.

Also fuelling this inflow were anaemic domestic growth and low interest policies of central banks in developed countries. The easing of sovereign debt fears in Europe by the end of the year also led to more FII inflows from Euro-based fund houses.

However, four months into 2011, there are many risk factors that have led to sharp corrections in individual stocks and in the broader market. Any negative earnings surprises have been followed by large shorting by foreign funds. This has been the case especially in capital goods and other industries that have seen margin pressures due to rising commodity prices and which have a limited ability to pass them through to end consumers. Also, continually high levels of inflation have been met with repeated rounds of rate hikes by the RBI, further adding to the cost of doing business faced by companies.

Crude truth

India is the only emerging market with a large fiscal deficit and a large debt/GDP ratio. Crude makes up a large proportion of our import basket and a sharp spike in oil prices due to civil unrest in the West Asia/North Africa has led to increasing worries about the amount of government borrowing required to pay for the deficit.

Also, improving business conditions in the developed world have led to reverse flows back to developed country markets. Strong corporate earnings, ultra low interest rates and the prospect of their sustenance for the rest of the year after the recent Fed announcement have led to large gains in American markets.

Fund managers are rotating focus within emerging markets from India and China to markets with more attractive valuations such as Taiwan, Korea and Brazil.

So far, FII flows into India in the first four months of the year have seen strong inflows in March and April after net outflows in January and February. The last week of April has seen a large selloff that has continued into May as FIIs have sold $500 million.

However, inflows in FY11 of $10-15 billion are likely on the back of recent measures taken by the RBI and SEBI that will likely act as strong drivers of inflows once the short-term correction due to the policy rate hike is factored in. These include the permission given to FIIs to invest in Indian AMCs.

FDI flows have seen 25 per cent drop during the past 12 months year-on-year. The Mumbai-Pune and NCR region continue to account for over half of all FDI into India. BP's $7.2-billion investment in Reliance's hydrocarbon assets was the largest in India's history and will hopefully lead to renewed confidence in India's business potential.

There are reportedly many such deals in the offing in several sectors including ITES and telecom but the biggest bottleneck continues to be red tape and the problems associated with large-scale land acquisition that have stymied foreign and Indian businesses.

Policy change

India has done dismally in the latest ‘Doing Business' survey, ranking 134 out of 183 countries. It takes a long time to obtain clearances, with complicated property registration, tax statutes discouraging potential investors. However, recent changes in FDI policy such as scrapping the requirement that a foreign investor obtain domestic joint venture partner approval before fresh investment outside the joint venture will help boost sentiment.

The author is Executive Vice-President, Fullerton Securities and Wealth Advisors Ltd.

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