Capital inflows in the Indian economy have recently been strong. In the first nine months of CY10, FIIs pumped in around $20 billion (net) into Indian equities, highest in the past decade.
They were particularly phenomenal in September, at $6 billion, almost similar to total net inflows in the first six months of CY10. In fact, debt inflows have also been robust at $10 billion so far in CY10, with September being particularly robust. Among major emerging markets (EMs), India outperformed in attracting foreign capital( South Korea got $12 billion).
So, what’s going on? The explanation for India’s spectacular performance is both in domestic as well as global factors. The rebound in the country’s economic growth has been impressive, and in a global environment where growth is becoming scarce, India continues to offer a high single-digit and quality growth rate. In addition, while the country’s export dependence and financial integration have increased meaningfully over the past decade, its growth dynamics are not too lop-sided towards the export sector, which is in sharp contrast to many Asian peers. This absence of imbalance in growth drivers places India much more favourably in the process of adjustments of global imbalances.
Yet, the relative attractiveness of India may not fully explain such a sharp rise in capital inflows, particularly in August and September.
This sudden spurt largely coincided with a shift in the monetary stance of major central banks, particularly the US Fed, towards further monetary easing. In the August Federal Open Market Committee meet, the Fed decided to keep the size of security holdings stable by re-investing the principal payments. Further, in September it hinted at the possibility of renewal of quantitative easing. Similarly, the Bank of Japan, very recently, not only cut interest rates to zero but also introduced an asset purchase programme. Such actions by major central banks boosted investors’ sentiments globally, resulting in money flowing into high yielding assets such as EM equities and debt, precious metals and commodities.
The combination of robust domestic economic environment and ample global liquidity, positions India quite favourably and this would keep the capital inflows to India strong in the coming months.
However, caution is also warranted. Persistently large inflow of capital creates fresh challenges for monetary policy by putting upward pressure on the Indian rupee and other asset prices. Second, the move towards further monetary easing by Fed and other central banks is, to a certain degree, reflective of the sluggish demand in the western economies and global race for weaker exchange rates. This could potentially lead to trade frictions and hurt business and investment sentiments globally.
The author is Head-Research, Edelweiss Securities
