NDA 2.0 aims to make the domestic markets more attractive and accessible to foreign investors
Domestic institutional investors, including mutual funds and insurance firms, are net sellers of equities to the tune of nearly ₹8,000 crore in the first 6 months of 2019
In April this year, a Singapore-based fund manager on a visit to India made headlines after he fell into an open manhole, just a few metres from a shopping mall in Mumbai’s Lower Parel, once home to the city’s textile mills and now a bustling business district. The man survived but the incident was a grim reminder of the many inherent risks that come with investing in India.
Mumbai, the country’s financial capital that boasts of the world’s 10th largest stock exchange and headquarters of multibillion-dollarconglomerates, is also an example of India’s crumbling infrastructure. The city is a reflection of the many contrasts that make up the Indian economy. On the one hand, investors are attracted by the country’s promise of a grand domestic consumption growth story; on the other, they have to countenance constant governance challenges, policy flip-flops, poor regulatory frameworks and under-performing sectors. Like the Singapore-based fund manager, investing in India can leave one bruised.
The Narendra Modi-led government has been spearheading steps to reignite the engines of growth. However, that momentum has slowed in the past year due to subdued consumer demand, a liquidity crunch hitting the non-bank sector and impacting credit growth, and corporate governance issues that have hurt investor confidence.
The fall-out of the defaults at Infrastructure Leasing & Financial Services Ltd (IL&FS) group have led to many questions about the way rating agencies and auditing firms operate in the country. While auditors face the heat from investigative agencies, the liquidity crisis sparked by the IL&FS saga has seen an erosion in the credit profile of several companies.
Institutional investors have been caught unawares as papers they were holding yesterday, and considered highly rated, has suddenly turned junk. These hidden risks have made investors jittery.
“Improved disclosure and transparency by corporates will be important to win back the trust of the investors. Making auditors and credit rating agencies more accountable for their actions will go a long way towards making equity markets safer," said Hemant Daga, deputy chief executive officer Edelweiss Global Wealth and Asset Management Ltd.
Apart from the recent concerns on corporate governance and liquidity challenges, investors have been disappointed by the returns from the Indian markets in the last decade, despite the long-term growth promise. Consistently, weak corporate earnings growth has contributed to this under-performance of the market.
According to Sanjeev Prasad, managing director, Kotak Institutional Equities, the Indian market has delivered mediocre returns over the last 10 years (10.5% compound annual growth rate). This year too, the performance of the Indian stock markets has been underwhelming.
The benchmark indices rising nearly 10% and foreign institutional investment just short of $12 billion in 2019 may indicate that investor wealth is swelling, but the reality is different. Domestic institutional investors (DIIs), including mutual funds and insurance companies, are net sellers of Indian equities to the tune of nearly ₹8,000 crore in the first six months of 2019. This year, the MSCI World index comprising stocks from 23 countries has risen 16%, outperforming the Indian market.
“External risks remain. Higher commodity prices (especially oil) will hurt Indian growth and consequently equity markets. De-globalization trends reduce the opportunity for India to export," said Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch.
Prasad at Kotak said foreign investors continue to find India relatively expensive and the new government needs to push big ticket reforms to convince them to open their wallets.
“India continues to be an expensive market relative to other EMs (emerging markets) and FPIs (foreign portfolio investors) are struggling to find value in consumption-related stocks in India. They like the long-term India story, but would probably wait for the right valuations and more visibility on the next-generation economic reforms before committing larger investments," Prasad added.
Aiding New Capital Inflows
Amid these challenges, the first budget of National Democratic Alliance 2.0, presented by finance minister Nirmala Sitharaman, is aimed at increasing the attractiveness of India to foreign investors by proposing a slew of reforms.
“An important determinant of attracting cross-border investments is availability of investible stock to the FPIs. This issue assumes greater significance in view of the gradual shift, from stock targeted investments, towards passive investment whereby funds track global indices composition of which depends upon available floating stock," Sitharaman said.
In her maiden budget speech, the finance minister proposed to increase the statutory limit for FPI investment in a company from 24% to sectoral foreign investment limit with option given to the concerned corporates to limit it to a lower threshold. FPIs will be permitted to subscribe to listed debt securities issued by real estate investment trusts (REITs) and infrastructure investment trusts (InvITs), she added.
The finance minister has also proposed to permit investments made by FIIs/FPIs in debt securities issued by infrastructure debt fund—non-banking financial companies (IDF-NBFCs) to be transferred and sold to any domestic investor within the specified lock-in period.
Another major area which will see easing of norms is the know your customer (KYC) requirements for FPIs. “As a key source of capital to the Indian economy, it is important to ensure a harmonized and hassle-free investment experience for FPIs. Hence, it is proposed to rationalize and streamline the existing KYC norms for FPIs to make it more investor-friendly without compromising the integrity of cross-border capital flows," she said in the budget.
Investors welcomed the moves to make domestic markets more accessible to foreign investors. “If you look at the overall intent of the budget, it is to make regulations for FPIs easier for them to increase their access to Indian markets. They have also opened up the norms for FPI investments in REITs and bonds of NBFCs. From that perspective, this budget is overall positive in terms of attracting FPI money," said Daga at Edelweiss.