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Foreign portfolio investments face headwinds

by Mahesh Vyas

Foreign investment inflows data released by the Reserve Bank of India on May 10 show that there was an outflow of USD 2.35 billion by foreign institutional investors during February 2018.

A net outflow by foreign institutional investors hasn’t been common in recent months. In the past 24 months there were only five instances of FPI flows being net negative. Of these, two were the ones just following demonetisation. Therefore, the net outflow of February was unusual.

Data available from the securities depositories suggest that FPI flows could be mildly positive in March 2018 - about USD 942 million. As a result, 2017-18 is likely to end with a net inflow between USD 21 billion and USD 22 billion. This would be a bit lower than our projection of inflows of USD 23.7 billion during the year.

Nevertheless, the USD 21-22 billion net inflow on account of FPIs compares with the inflows of USD 7.6 billion in 2016-17 and outflows of USD 4.5 billion in 2015-16. But, it would be lower than the surge seen in inflows immediately after the formation of the Modi sarkar, to USD 40.9 billion in 2014-15.

Foreign portfolio investments in 2018-19 are expected to remain net negative. Our projection was a net outflow of USD 269 million. This projection is based on the fact that equity valuations in India have been aggressive for a long time and corporate earnings are unable to match these valuations. Early results of companies’ performance during the March 2018 quarter do not indicate any improvement on this front.

Political uncertainty in an election-intensive year would play upon institutional investors’ decisions regarding their exposure to India as well. Emerging markets are risky in general. In an election year, India is riskier than it is usually.

But, net FPI flows, it appears may turnout to be worse than our expectations during 2018-19.

In April 2018, FPI flows were negative. Total net outflows were of the order of USD 2,765 million. Net equity outflow was USD 983 million and net debt outflow was USD 1,785 million. This was the third consecutive month of outflows on debt securities.

Debt security investments by FPIs, essentially investments into G-secs, are hit because of rising yields and also a depreciating rupee.

The government has taken steps (albeit mild ones) to stem the outflow of FPI dollars. On April 6, it raised the limit for FPI investment in G-secs from 5 per cent to 5.5 per cent of the outstanding amount in 2018-19 and to 6 per cent in 2019-20. Evidently, this has not stemmed the outflow of FPI investments into debt securities in India.

On April 27 and then on May 1, the RBI announced changes in FPI investments in G-secs to remove minimum residual maturity requirements with the condition that investments into securities with less than one year maturity do not account for more than 20 per cent of the total investment. FPIs are now permitted to invest into treasury bills issued by the central government. FPIs can also invest into corporate bonds with a minimum residual maturity of one year compared to a minimum requirement of three years residual maturity earlier.

RBI seems to have allowed the risks associated with permitting short-term overseas investments.

However, the core issues are rising yields and a depreciating rupee. Add to this are the several restrictions put on FPIs on their investments into bonds which, reportedly are disconnected from ground realities. Further, according to a report filed by Sugata Ghosh and Reena Zachariah in Economic Times, SEBI has asked custodians to draw a list of high-risk jurisdictions that could be used for money laundering and round-tripping of funds. Ostensibly, the move aims to curb the flow of unaccounted wealth but, this would only make capital flows from NRIs a bit more difficult in 2018-19.

Finally, global markets are not well poised to increase exposure to emerging markets. US 10-year treasury bond yields have touched 3 per cent for the first time since 2014 and according a report in Wall Street Journal on May 12, investors pulled out USD 4 billion from emerging markets over the past three weeks while they had poured in USD 70 billion into these last year.

India cannot take FPIs for granted in 2018-19. It is apparent that our projection made in March 2018 for 2018-19 warrants a downward correction. And, given RBI’s recent changes to policies governing FPI flows into debt securities, we may also see a little more volatility in these flows during the year.