Selling by foreign institutional investors (FIIs) has clearly accelerated. Almost $4 billion (Rs 24,000 crore) exited India's equity markets in the past three months. In the last two days alone, global investors sold equities worth over $400 million (Rs 2,400 crore). It is no longer just hedge funds shorting stocks or even selling based on exchange-traded funds. We are now seeing large, long-term capital providers selling down their holdings in India, as evidenced by the price damage in stocks like the HDFC twins, ITC and Sun Pharma.
Why are FIIs giving up on India? Why are they willing to exit now, even though the markets are down over 30 per cent in dollars for the year? It is not because it is hot money, prone to running at the first sign of stress. Instead, investors now finally seem to be throwing in the towel. They are unable to deal with India's volatility or the need to constantly defend the country internally to an investment committee. Investors fear that a crisis is brewing, thanks to Indian policy makers' inability to bring the situation under control.
First of all, there is great fear surrounding the fiscal deficit given the fact that, in rupee terms, the Indian oil basket (for imports) is at an all-time high. It is inconceivable that Finance Minister P Chidambaram could have any chance of meeting his 4.8 per cent fiscal target. Oil and fertiliser subsidies have multiplied. The projected revenue targets seem unrealistic (tax revenue is already down to single-digit growth) and the revenues projected from disinvestment and spectrum sale are nowhere in sight. Moreover, the food security Bill will only add to the burden.
Yet, the finance minister will have to deliver on the fiscal target to avoid a ratings downgrade. The road to a ratings downgrade is a path no one wants to even contemplate. The only route open to him to meet the deficit target is to once again savagely chop all Plan expenditure, as he did in 2012-13. Yet, if he slashes Plan expenditure, how will we get the push to kick-start investment? There is absolutely no confidence, balance sheet strength or willingness on the part of the private sector to make fresh investments in the country. So the investment cycle can only be kick-started by the government. But if we are going to slash Plan expenditure, this push to investment cannot happen. The skewed mix of growth (consumption at the cost of investment) will also remain unchanged, and surely there are limits to how long this growth imbalance can continue. India's problem is more supply-side than demand-side, and a savage cutting of Plan expenditure will do nothing to remedy the supply-side issues. Without a push from the public sector, we will remain stuck at five per cent growth.
Investors also worry about inflation. Any attempt to cut fuel subsidies will lead to a spike in inflation, as we align diesel prices to global levels. Besides, rising prices of imported coal will also cascade through the system. And what if China starts recovering and commodity prices move up in tandem? Imported inflation is going to be a major issue; it seriously reduces any space the central bank may have to cut rates. Again, without rate cuts, how will we get the economy moving again?
The banking system is a huge pain point. Financial stocks were over-owned and have got battered in the last three weeks. None of the banks had expected the reversal in interest rates and the tightening of short-term liquidity (to defend the rupee) engineered by the Reserve Bank of India (RBI). Consequently, we have huge marked-to-market losses of almost Rs 40,000 crore on the portfolio of government securities the banking system holds. Add to these the losses on corporate bond portfolios. Asset quality continues to deteriorate. Also, now that the rupee is near 70, more than a few large groups are in stress on their unhedged foreign currency borrowings. The RBI has already given some dispensation and will have to give more to allow banks to not report these large marked-to-market bond losses. One should also expect the RBI to be lenient on restructuring and recognising non-performing assets. "Extend and pretend" will have to be the mantra, so that there is no loss of confidence in the banking system. Banks' net interest margins are also under pressure since wholesale funding costs have moved to 10.5 to 11 per cent. System credit growth is, at best, going to be 12 to 13 per cent. Investors are beginning to look through all the regulatory dispensation and focus on economic earnings, which do not look pretty.
The government lacks credibility in the eyes of investors. The finance minister, in trying to get the economy out of its funk, continues to cut a lonely figure. No one else in government seems to have any sense of urgency as to how close to the edge we are.
It is amazing that no public sector undertaking has yet tapped global capital markets. What are we waiting for? If the rupee keeps sliding, the markets may shut for Indian paper. We cannot wait for weeks for boards to meet - the Indian government is the majority owner, and it should act. Why are we delaying putting in place swap lines and non-resident Indian bonds? To stabilise the rupee in the short term, we need to rebuild confidence. The markets are still open for India to access capital, but this can change quickly.
On politics, it is amazing that the only thing to have come out of the monsoon session of Parliament so far is the food security Bill. Political parties cannot agree on the goods and services tax; coal block auctions; pension and insurance reforms; environmental issues or foreign direct investment; and judicial, police and governance reforms. There is, however, unanimity on the food security Bill. The Bharatiya Janata Party and Narendra Modi even wanted to universalise the legislation and raise the amount of grain to the poor to 35 kilogrammes. Investors are questioning the political class' priorities and the willingness to appear populist at any cost. What about jobs and income growth? Are these factors not politically relevant? No one seems capable of looking beyond populism and hand-outs, let alone improving governance and carrying out structural reforms to regain growth. The political system in India seems either incapable or uninterested when it comes to taking tough decisions. Why invest in a country where the entire political system seems to be in denial?
Investors are beginning to lose hope and give up on the country. Redemptions out of the emerging market equity asset class are the catalyst, but many are just tired of waiting for India to get its act together. With zero returns in dollars over a five-year period, many are asking how much longer they are expected to wait to see positive numbers.
Nothing they see inspires confidence. Growth is slowing; inflation and the fiscal deficit remain high; the government lacks co-ordination; and there seems to be no end to India's currency woes. We should maybe hope for another crisis in the West. That could perhaps give us the breathing space to continue.
The writer is fund manager and CEO of Amansa Capital
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
