FIIs on a "quit India" spree

If nuclear tests and the subsequent sanctions by the US and other countries upset the applecart of leading FIIs, their cup of woes started brimming over after the union budget which failed to buck up their spirit. FIIs had pulled out nearlyRs 1,000 crore from the markets in May alone. “In the short-term we expect FII inflows to be adversely affected by the likely swadeshi tilt of the budget. The local speculators have overbought and are likely to unwind positions,” said Merrill Lynch, a leading foreign investment firm.

After the South-east Asian crisis, there was a general perception that foreign funds will increase their exposure to Indian markets. The reason propagated at that time was that unlike Thailand, Indonesia, Malaysia and South Korea, Indian markets are insulated from the rest of the world and won’t face any major recessionary phase. Many leading FIIs had burnt their fingers in South-east Asia and cut their exposure to the region.

Simultaneously, many experts had predicted that they would allocate more funds to India and other healthy emerging markets in Asia, but it never happened as political uncertainty before the elections, sanctions, downgrading and rupee volatility took their toll.

“After the downgrading ofIndia’s outlook by Standard & Poor’s and the imminent downgrading of the country’s rating by Moody’s have now put a spoke on the wheels of FIIs. They allocate funds on the basis of the country’s rating. If the rating is downgraded, then naturally the fund flow will also reduce,” said an official with a leading foreign investment firm. Moody’s and Standard & Poor’s had expressed disappointment at “lack of steps” in the recent union budget to address the large fiscal deficit. According to Merrill Lynch, foreign investors have taken the sharp increase in import tariffs as a reversal of the reform process. “The inflationary impact of the budget could lead to a slowdown in demand,” it said, adding that foreign investors are likely to be disappointed by the lack of specific measures to boost foreign direct investment, especially in the light of sanctions imposed against the country. Besides, there was no specific concessions for the capital market such as reduction in the capital gains tax and permission forpension funds to invest in equity markets.

As many as 505 FIIs registered with the SEBI have so far invested $ 9.043 billion in Indian markets. Even though the net FII investment is less than one-tenth of the total market capitalisation (total market value of all listed shares) of over Rs 4,00,000 crore, if they suddenly pull out money they can create a crisis situation on the stock exchanges, threatening the solvency and integrity of the financial system itself. Experts like former UTI chairman G S Patel feel that FII investment is generally short-term in nature and does not lead to creation of assets. A section of the market community has been clamouring for tight FII investment norms. On top of this, FIIs need to pay only 10 per cent long term capital gains tax on liquidation of their share assets while resident Indians end up paying more tax. When the South-east Asian markets went into a turmoil, FIIs were the first to pull out money, leaving these markets in a lurch. This may not be liked by majorityof investors in India who are essentially conservative and interested in the safety and security of their capital and some appreciation.

Apart from the FII selling in domestic markets, foreign investors are dumping GDRs (global depository receipts) of Indian companies listed on overseas markets. The Skindia GDR index is currently 1.51 per cent above its all-time low of 672.50. The lack of interest in Indian shares will dampen the plans of many Indian companies to float GDR issues. The government has planned GDR issues in the case of Concor, Indian Oil and GAIL. Now it is to be seen whether foreign investors will grab Indian paper as they used to do earlier.