Who said FIIs are betting on reforms?

If you set yourself up as a market expert, you can't admit to being flummoxed by market movements. That is why market players, when asked why the Sensex shot up this year, despite the snail-paced economy and sluggish corporate profits, come up with so many answers.

‘It is a liquidity-driven rally', some say, deadpan. ‘It's the government’s big reforms push. That has made foreign institutional investors bullish about India’, others exclaim. A few point out that the global perception about India has changed, with a new Finance Minister who is seen as pro-markets and pro-business.

The Government also seems to be quite caught up in the notion that it is reform announcements that bring in FII money. Since September, not a single week has gone by without some heavy-duty policy announcement.

In fact, going by the haste with which recent policy pronouncements such as the direct transfer of subsidies or the National Investment Board have been made, the motto now seems to be “Announce it this week, we’ll figure out how to do it later”.

But numbers suggest that the $22 billion in foreign institutional investor (FII) flows that have powered this rally, may owe quite a lot to global factors and relatively little to newfound enthusiasm about India's reformist zeal.

Already underway

To start with, there is the timing of the flows. People forget that the stock market rally was already well underway before this frenzy of reforms was unleashed.

By mid-September, when the government announced its first major move — the diesel price hike — the Sensex had already zoomed all the way from 15,500 (its January level) to nearly 18,000.

This was fuelled by an influx of FII money. In fact, $13 billion of the $22 billion FII inflows for 2012 were already lodged in Indian stocks by end-August.

Hey, what about the gush of money that came in after September? After all, $9 billion in three months is a big deal too. It certainly is. But there is no way of ascertaining if this was a bet on India either.

Aided by QE

It was exactly in early September, when India was still readying its reforms agenda that central bankers in the Europe and the US launched their last and most aggressive round of quantitative easing measures (the now-famous QE3).

On September 6, the European Central Bank launched a bond buying plan to lower borrowing costs and to ‘do what it takes' to preserve the euro.

Ben Bernanke quickly followed, announcing on September 13 that the US Fed would buy back $40 billion of bonds every month, also promising to keep US interest rates close to zero for another three years.

What distinguished QE3 from the previous liquidity-enhancing measures was its sweeping open-endedness.

It basically promised to keep the global floodgates of liquidity open for an indeterminate period, until economic revival was a given.

With that sort of a carte blanche to the markets, is it any surprise that global liquidity has been flooding hither and thither in the last three months?

The QE3 announcement sparked off a rise not just in India's Sensex, but in the entire pack of emerging market stocks, as well as commodities ranging from copper to gold.

These assets rose in expectation that the free money sloshing around in the developed markets would find its way into riskier ‘growth' themes such as commodities and emerging markets, for better returns.

An emerging markets bet

That global investors have been betting on emerging markets and Asia as a general theme, and not singling out India for their munificence, is also clear from the composition of FII money that has flowed in this year.

Data compiled by institutional broker BNP Paribas Securities show that at least $10 billion of the $18 billion FII money that rushed into India in the first ten months came from global emerging market funds or Asia (ex-Japan) funds.

This suggests that a large chunk of recent FII flows into India are the result of global investors betting vaguely on the premise that emerging markets will deliver the long-term growth that is so elusive in the Western world. Indian markets are merely receiving an automatic share of these allocations.

Interestingly, while global investors were pouring money into emerging market and Asia funds, they were actually pulling out money from specialised India-dedicated funds!

Clearly, no matter what corporate lobbyists would have us believe, global investors have not been waiting with bated breath for India to approve the PFRDA Bill, throw open its supermarket sector to Walmart or cut back on subsidised gas cylinders to its households.

After all, even if foreign direct investment in airlines or super markets is a great ‘signalling' move that India is serious about reforms, these moves would make hardly any difference to corporate India's prospects or even the performance of equity markets.

Airline and retail companies put together account for less than 1 per cent of the market capitalisation of stocks listed on Indian markets. The sum total of FII investments in these two sectors today is a measly Rs 3,000 crore, less than 0.5 per cent of their total India exposure.

What all this suggests is that, having done its bit to mend its public image of being paralysed by inaction, the Government can now afford to pause for breath and take a more pragmatic view of reforms. In this context, it may help to substitute quantity with some quality.

After all, moves that signal intent may draw in a deluge of FII money at a time when the global markets are flush with liquidity. But for those investments to stay put in India, especially when the tide turns, the fundamentals of the economy and that of corporate India will need to justify it.

That will mean action on the ground to subdue inflation, lift consumer confidence and kick-start the stalling investment cycle.

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