India's reliance on FII flows reduces; trend seen as positive for economy

FII flows as a percentage of FDI lowest since 2003; trend seen as positive for the economy

The flows from foreign institutional investors (FIIs) into India have been thinning, but there is reason to cheer, given the share of foreign direct investments (FDIs) in overall foreign flows is gaining prominence. 

The shift in balance has reduced the share of portfolio flows into equities as a percentage of FDI to its lowest level in the last 14 years.

Experts say this trend is favourable for the domestic economy as FDI money, unlike FII flows, is less bound by short-term gains and therefore less volatile. “The good news is that a large part of capital flows coming into India has moved to the FDI route, which is less sensitive to shift in investor sentiment,” said Ridham Desai, Managing Director at Morgan Stanley India. 

Echoing the sentiment, Jyotivardhan Jaipuria, founder and chief executive officer of Valentis Advisors, said: “Money coming in through the FDI route tends to stay longer, creates new capacities and jobs. Therefore, it is more desirable.”  

As of April this year, FII flows as a percentage of FDI stood at 4 per cent, the lowest level since the Reserve Bank of India (RBI) started collating the data in 2003. From April onwards, FII flows have turned negative for the year, indicating that FDI has gained even more prominence in the overall scheme of things.

On a year-to-date basis, FIIs have pulled out $5 billion from equity markets. 

While a large inflow from FIIs could shore up the equity markets, large pull-outs can also lead to sharp volatility in currency markets, consequently putting pressure on the rupee. 

The combined FII pull-out from equity and debt markets this year is $14 billion. The rupee has depreciated 12.4 per cent against the dollar over the same period. 

This volatility has a wider impact on the overall economy. “If you go back — excluding the last five years — almost 80 per cent of capital flows came through FIIs. Therefore, India was over-reliant on capital markets to fund its balance sheet. That led to volatility in economic growth,” Desai added.  

Between 2003 and 2012, the FII flow as a percentage of FDI flow, on an average, stood at 165 per cent. This means that for every $100 invested through FDI during this period, FIIs invested $165.

Since 2013, this trend seems to have reversed. Between 2013 and 2017, the FII flow as percentage of FDI has been hovering around 30 per cent. So, for every $100 coming through the FDI route, $30 comes by the way of FIIs. 

“The rising share of FDI will make the domestic economy less sensitive to external flows. Even though it would not make India immune to flows, the implications would be limited as compared to the past,” Desai said. 

Experts say that though the rising prominence of FDIs is favourable, these flows need to be driven more towards the real economy. 

“At least 30 per cent of the FDI flows to have come into India has moved into growth sectors like e-commerce. Other sectors that have attracted FDI flows are non-banking financial companies and real estate. If these flows are directed more towards sectors linked to real economy, the impact could be much larger,” said Kunj Bansal, partner and chief investment officer at Sarthi group.  

  

Further, experts said that the scale of FDI into India is still low, as compared to other economies like India. With the right drivers in place, there is huge scope for attracting even more FDI flows, they added.