Problem of plenty

Foreign investors seem to be taking a rather more sanguine view of India’s economic prospects than domestic institutions and the commentariat. At least that’s the inference one draws from unabated inflows from foreign portfolio investors and direct investors in the post-Covid period. Government data show that Foreign Direct Investment (FDI) in July-September 2020, at $28 billion, was double the same period last year. If one considers the last six months to smooth out flows and looks at only incremental equity investments, FDI into India at $30 billion has still seen a 15 per cent increase. Net investments by Foreign Portfolio Investors (FPIs) in Indian equities, after faltering a bit in September, have turned into a gusher with inflows of ₹1.56-lakh crore this fiscal, including record in November . While strong inflows are definitely desirable at a time when India’s capex cycle needs a fresh start, their sustainability cannot be taken for granted.

At a macro level, three factors could be behind the optimism despite the economy entering a technical recession. One, after the 23.9 per cent contraction in Q1, high-frequency indicators have shown a faster-than-expected normalisation since September, prompting GDP upgrades. Two, listed companies and late stage start-ups — two key recipients of FPI and FDI flows — have weathered Covid relatively well. Listed companies managed a 31 per cent rebound in their net profits in Q2 helped by cost savings, interest rate cuts and a shift to the formal sector. Tech start-ups have been key beneficiaries of the digitalisation and consumer migration to online transactions. Three, recent reforms on FDI, production linked incentives and the steep corporate tax cuts have also aided flows. These, however, do not fully explain the story; there’s also the liquidity tailwinds powering record flows. The resumption of money-printing by central banks keen to shield their economies from Covid has played no small role in the gush of global liquidity that has inflated public and private market valuations. Should central banks stop or even pause in their efforts, the tide could recede as quickly as it rushed in. The Indian market is poised at a historically high valuation (the Nifty PE is at 31 times) and will be particularly at risk. FDI flows into India remain heavily dependent on individual deals sewn up by the leading lights of India Inc and remain unpredictable.

The liquidity gusher has created an unusual problem of plenty for the Reserve Bank of India (RBI), which has been mopping up dollars in its bid to prevent sharp Rupee appreciation. But with the market interventions contributing to excessive liquidity with banks, forcing down market interest rates and fuelling inflation risks, RBI must perhaps consider letting the Rupee find its own level. Plentiful flows also offer a rare opportunity for Indian regulators to more closely scrutinise the quality of money rushing in, by tightening the screws on Participatory Notes and round-tripping through brass-plate entities.