Destination India

It is striking that the recent market turbulence following renewed concerns over the global economy has not triggered a large-scale foreign institutional investor (FII) pull-out, unlike in 2008, when the outstanding portfolio investments fell by $34 billion. While the Sensex has shed a fifth of its November 2010 highs, data from the exchanges suggest it is not the FIIs, but Indian retail investors, that have done most of the selling. Not that the FIIs haven't had any provocation to head for the exit door. Globally, the recovery in the US (even if not accompanied by job growth), sovereign default worries in Europe and political uprisings in the Arab world have prompted capital flight away from risky assets. In India, a nationwide anti-corruption mood and newfound regulatory activism stemming from the unearthing of a series of scams, has led to a near-standstill in policymaking. That has, in turn, dampened investment confidence, even as Indian corporates have seen a sharp deceleration in earnings momentum, with rising interest rates, wages and other input costs eating into their margins. That the FIIs have remained marginal net buyers despite all this probably represents a residual hope, even if not a ringing vote of confidence, in India's long-term growth story.

Cynics will, no doubt, say that the FIIs choosing to stay put has to do mainly with the chaotic global investment climate that makes India look better. Moreover, by virtue of owning nearly a third of the free float in the Indian stock universe, they would themselves lose most from precipitating a crash, a la 2008. However, there might still be some positive takeaways from the recent stability in FII flows. One, it could signify a changed perception among FIIs of Indian stocks representing a reasonable long-term investment rather than a risky short-term trading bet. To the extent they believe that the problems stalling India's economic growth are not structurally insurmountable, the FIIs would seem more sanguine than domestic retail investors, who have opted for gold or bank deposits. Two, the basic profile of foreign portfolio investors itself may have undergone a change. In 2007-08, it was hedge funds, keen to make quick gains from each market move, that dominated the scene. Today, the ones cropping up most in the list of foreign investors are exchange traded funds, emerging market mutual funds and pension funds with a longer investment horizon.

However, the recent calm on the FII front should be no reason for complacency. What it provides is a short window of opportunity for the Government to resolve critical growth-crippling bottlenecks in power, coal, transport and other infrastructure, besides pushing ahead with long-pending reforms in retail, energy pricing, labour, finance and agriculture. If it fails in this, FIIs may well find other emerging markets offering better growth prospects.

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