Hot FDI and FII Money Flooding Back into India

15 October 2009. Normally brash Mumbai felt a little flat at the start of 2009 – as did most places.

15 October 2009. Normally brash Mumbai felt a little flat at the start of 2009 – as did most places. To be quite honest, it was a bit scary, which is why I asked in my inaugural piece for EconomyWatch.com back in May, Where Have All the Jobs and Cranes Gone?[br]

We had heard a giant sucking sound as foreigners pulled their money out of the country. The money from Foreign Direct Investment, or FDI, and the less well know Foreign Institutional Investors, or FII (who buy into stocks and funds), have been a key part of India’s growth story this decade. As I reported at the time, by last year investment made up 39% of India’s GDP, compared to 25% in 2003, and a third of that came from foreigners.

By that time, FDI was down about a third on the previous year, and as it turned out May marked the low point. FDI was down a eye-watering 46% in May to $2.1 billion. But that marked the button. As global markets turned around, and with the comprehensive victory for Congress in the General Elections bringing confidence in India to higher levels, things turned around.

In June, there was a slight year-on-year increase of FDI to 7%, and by July it really took off, growing 55% to $3.5 billion. The Reserve Bank of India has just announced that August saw another growth spur, with inflows up 40.4% to $3.27 billion. [br]

The Economic Times has just reported that FII investment is up, with the Indian Stock Market taking in $13 billion so far in 2009 from foreign institutions. This is in stark contrast to 2008, when FII’s pulled $2.4 billion out of the market. FIIs such as pensions managers, investment houses and sovereign wealth funds have been both a growth driver and a beneficiary of that growth, with stocks now worth more than double what they were at their March lows.

in Q2, there was a combined $15 billion inflow in both FDI and FII money. Although the numbers aren’t yet tabulated, Q3 is going to be bigger – probably the biggest quarter ever.

This year, then, is a tale of two halves, and where the year started with that sucking sound, now there is a wave of money crashing over India. This is a strange question to ask, but is that a good thing?

Sadly the Indian media doesn’t address this question very well, but an excellent New York Times article examines some of the problem. Clearly India needs better infrastructure and more open markets, and money generally helps in different ways in both areas. It has also helped to restore the natural bullishness of Indians, who are shopping and investing themselves like crazy. Our assets are going up in value, which is good for all of us who have something to our name.

However ‘hot’ inflows carry some health warnings. As we have seen at the start of the year, money can go out even faster than it comes in, and that can be extremely de-stabilizing on an economy whose debts levels are second only to the US.

The flows naturally move faster than our Government and the tangled web of the civil service at both state and federal level – but it is at this level that investment and reform is most urgently needed. Investors may well flee again if there is no quick sign of progress.

If the money continues to flow in, however, there are another set of problems. Asset prices are starting to look bubble-like again. For example, stocks are just 20 per cent off their peak in 2008, but profits are less and revenue growth slower.

“Because we are a fairly large attractor of capital, the possibilities of bubbles building up in sectors like real estate are very real,” said HDFC chief economist Abheek Barua, who is forecasting economic growth. “It has clearly happened in China and there is some of that sort of problem here, as well.”

Inflows have also helped push the value of the rupee up by 11% this year against the dollar, making exports less competitive.

And with the Consumer Price Index already nudging up to 12%, further growth in stocks and house prices is likely to bring back the spectre of high inflation in India, which leads both to economic hardship and social unrest. There are strong hints coming out of the RBI that interest rates will have to go up.

So while we should rightfully celebrate being back in the go-go-growth mode, we should remember recent history and tread cautiously.

Dwayne Ramakrishnan, EconomyWatch.com