Not FIIs

There is a strong consensus that India is vulnerable owing to the large mass of FII investment in the country. The evidence is, however, increasingly falling into place about a rather different set of ground realities. FII inflow is seen as capricious. India's "vulnerability" to the FII is asserted repeatedly by a broad spectrum of politicians. Paradoxically, India's success in building a liquid equity market has made matters a bit worse. There are fluctuations in the global perspective about how emerging markets will fare. When global investors feel good about the prospects for the emerging markets asset-class, they are likely to buy into South Korea and India""the most liquid of the emerging markets. Conversely, when the outlook for emerging markets becomes bad, the FII cannot easily sell in Malaysia or Indonesia or Singapore. FIIs prefer to sell in South Korea and India""the countries where trading suffers the lowest transactions costs.

So how bad can it get? The recent period is a good example of the forces in play. From May 11 to 25, the sum of FII sales in the spot market added up to Rs 10,419 crore. However, at the same time, FIIs were net buyers in the equity derivatives market to the tune of Rs 5,257 crore. This gave an overall net equity sale by FIIs of Rs 5,162 crore""or a tad above $1 billion. When the outlook for Indian equities is gloomy, futures prices (which first respond to the views of speculators) go down. This opens up arbitrage opportunities involving selling shares on the spot market and buying on the futures market. Given the poor regulation of Indian finance companies, FIIs have shaped up as key players in derivatives arbitrage. This has yielded sale of shares coupled with purchase of index futures by FIIs.

The net sales by FIIs, of roughly $1 billion, in the two weeks of difficult times in emerging markets worldwide, coupled with an unremitting flow of bad news in India, is a remarkably modest number. It works out to perhaps 1.5% of the stock of FII investment in India and 0.15% of India's equity market capitalisation. The departure of $1 billion over a two-week period is particularly small when compared with daily equity trading of well over $10 billion. This suggests that the Indian equity market has ample liquidity when compared with the day-to-day entry and exit of foreign capital.

Far from coordinated behaviour on the part of FIIs, the data show a huge divergence of speculative views. In 2005, for example, while there was a net FII inflow of Rs 47,182 crore, this was made up by purchases of Rs 2,86,021 crore and sale of Rs 2,38,839 crore. There are over a thousand distinct FIIs. It is impossible for them to coordinate strategies. Some are buyers, some are sellers; they do not act as a class. These facts question the general assumption that foreign investors are likely to bolt from India in a coordinated fashion. As this newspaper has emphasised, the reasons for the drop in Indian equity prices are found within India. The country has had a flow of bad news, and local speculators have become less optimistic about the future. It is our local problems, and not FIIs, which hold the key to explaining why the Nifty P/E has dropped sharply.