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Money Dec 17, 2012

Hot money: FII bull-run might have little to do with reforms

By Sunainaa Chadha

Should markets really thank the change in guard at the finance ministry for the $22 billion (over Rs 1 lakh crore) foreign institutional inflow so far this year, or does the FII bull-run have more to do with global economics?

If one were to examine the Indian fundamentals, there is not much to rejoice about.

India's economy is still in the doldrums, despite the October IIP at 8.2 percent which was perhaps the result of a base effect. Even India's chief economic adviser Raghuram Rajan last week acknowledged that mere "Stabilisation is not enough, we need to grow faster."

Also, FIIs are buying at a time when India is slowing and is expected to grow only 5.5-6 percent in the current fiscal.

The impact of the FDI policy on the markets is largely symbolic and should be viewed as a relief bounce, and not a commencement of a rally. Reuters

Even the current account deficit and inflation continue to remain way above comfort levels, which is why interest rates continue to be high. The government in all likelihood is likely to miss the deficit target on the fiscal front.

The reform initiatives by the UPA, which include hike in fuel prices to contain fiscal slippages, liberalising capital account to improve Balance of Payments situation and hiking FDI limit in multi-brand retail and aviation, do suggest the government is getting serious about arresting the downturn, but implementation will still take a while. Yet FIIs are pumping in money into India shares without waiting for a complete economic recovery.

Anand Rathi, chairman of Anand Rathi Financial Services, has termed the reform initiatives as a relief but not a game changer for markets. In an interview toBusiness Standard, he says "The impact of the FDI policy on the markets is largely symbolic and should be viewed as a relief bounce, and not a commencement of a rally."

This is perhaps why domestic institutions have not rekindled faith in the Indian equity markets and have sold equities worth around Rs 42,000 crore, the highest in at least five years.

Even though India received $9 billion between September and November when the government pushed forward its reforms agenda, at around the same time central banks in Europe and the US launched their most aggressive round of quantitative easing by way of bond buying plans and promises of zero interest rates for another three years. An uncapped global liquidity situation will obviously flood markets where economies are expected to rebound faster than Euorpe and the US.

Hence this higher-than-expected FII inflow into the Indian market could well be a reflection of easy availability of money in the global financial system because an enhanced QE3 means more liquidity-fuelled rally into emerging markets that are expected to grow way faster than their western counterparts.

Aarati Krishnan in a column in the Hindu Business Line makes an interesting case. " QE3 announcement sparked off a rise not just in India's Sensex, but in the entire pack of emerging market stocks, as well as commodities ranging from copper to gold.These assets rose in expectation that the free money sloshing around in the developed markets would find its way into riskier 'growth' themes such as commodities and emerging markets, for better returns," she says.

This is because India has historically commanded a high share of foreign flows coming into Asia.

According to a report by brokerage Credit Suisse, India and China are likely to be main growth drivers among the BRIC nations and the growth gap between the two is expected to narrow since moderate investment spending and constraints to labour force growth would limit China's growth rate, while, India has the best potential to generate high growth over the longer term.

Even JP Morgan and Chase has picked Indian equities as its top market selection in FY13 among the BRIC nations as the Sensex, which has rallied 18 percent this year, is more than any other benchmark gauges of the BRIC nations.

Moreover, even among the BRIC economies, Brazil's commodity-focused economy has slowed, China's manufacturing data this year confirmed slowdown while there are many concerns about the political transition there. Russia is losing focus among investors due to high concentration of sector risks. Indonesia is the only other emerging nation of comparable size that continues to be attractive to FIIs.

"If India keep on delivering in terms of improving momentum on economic numbers, policy reforms, it should still attract sizeable flows going ahead into next year. I do not think we should be fearful of China taking away some of those allocations," said said Deepesh Pandey, Head - Investments, IIFL Capital, in an interview with CNBC-TV18.

This trend of liquidity flowing into equities is likely to continue in 2013 until the Western markets perk up and India will continue to receive a large chunk of Asia-pacific funds.

However, if Finance Minister P Chidambaram wants this FII love to continue, he has to ensure that the government can back this up with strong fundamentals and kick start the investment cycle, while corporates have to spruce up their balance sheets and pose strong numbers.

by Sunainaa Chadha

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