Foreign institutional investors (FIIs) are getting sober after pumping in nearly $5 billion into Indian equities and debt this month. The celebration rally began to taper last week, as FIIs began cashing out. They turned net sellers last Thursday. Profit-booking continues this week, heavily so in stock futures. The Sensex was pulled down 500 point on Monday in one such event as at least one foreign fund consolidated last week’s gains. Analysts’ views are getting real too. Deutsche Bank AG, for example, downgraded investment weights for India from neutral/overweight to just neutral, judging stocks too expensive and hence, overshot.
This behaviour is the strongest indicator yet of the type of foreign capital that has flown in recently—short-term and flighty. Another indicator is the reversal of foreign capital inflow into debt—from net sellers in April, FIIs bought this month; purchases have now even risen to match equities. Why should investors care about bonds at this point? There is nothing to show that either fiscal or inflation risk has reduced: if at all, advice to extend the fiscal deficit target from 4.1% to 4.5% of gross domestic product (GDP) to raise capital spending has been recently reported. And 12 May data showed headline consumer price inflation actually rose last month! Investors are buying short-tenure bonds, therefore.
From a fundamental perspective, there was little to excite investors, foreign or domestic, to start with, other than joy about the new government from which a lot is expected. This is not to dismiss the reassurance gained earlier by policymakers’ efforts—remarkably quick reversal of the current account, stabilization of the currency, fiscal consolidation, and stronger inflation focus, to name the major improvements.
Beyond these, however, real sector data continues to show a slowing economy. Monsoon risks to inflation are actually quite high. There isn’t an indication of any breach in stagflation. The night after, investors are getting real and will more look for betterment in these numbers now. And reforms, of course, that have long been held up due to coalition politics. That embargo lifted, investors’ interest will also be guided by structural changes that can generate sustainable growth for long periods of time. Such reforms will also help attract the kind of foreign capital India exactly needs—long-term, stable investments in spheres that yield more bang for the buck, viz. labour-intensive and export-oriented. That would help meet two of the most pressing economic policy objectives—employment generation and sustainable external balances. Meanwhile, the reality check will continue some more.
Renu Kohli is a New Delhi-based macroeconomist.
