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Indian GDP growth largely depends on capital flows

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Indian GDP growth largely depends on capital flows
Malini Bhupta / Mumbai Dec 14, 2011, 00:02 IST
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Boathouse Residences : Strategic Location With The Luxury of Riverine Living. Find Out More! May take a while to return to the 8% level, if capital flows dry up. India’s growth trajectory over the last decade has thrown up a direct link between capital flows and GDP expansion. While domestic consumption is a big growth booster, nearly 20 per cent of the country’s growth has been fuelled by capital flows — both portfolio and foreign direct investment (FDI). For instance, in financial year 2000-2001, while GDP grew 4.4 per cent year-on-year, capital flows stood at $6.5 billion. As foreign investors saw the emergence of a dynamic entrepreneurial class and a hungry middle class, they were willing to pay a premium for economic growth that promised to breach the nine per cent level. Consequently, between FY2005-06 and FY2007-08, the country saw inflows of over $94 billion (FDI and portfolio). The GDP expanded more than nine per cent in these years. However, in the post-Lehman world, growth plummeted to six per cent in FY2008-09, as foreign institutional investors (FIIs) pulled out $10 billion from Indian markets. Last year, India was the best performing stock market in Asia, as portfolio flows touched a whopping $24.3 billion. Even as some economies were plagued by anaemic growth, the country’s GDP expanded 8.5 per cent. Needless to say that a capital-starved economy like India would grow at a faster pace if it remains well-oiled with capital and its entrepreneurs get capital at affordable levels to expand businesses, kicking off a virtuous growth cycle.

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However, the worrying bit is that India is heavily reliant not on the more sticky FDI, but the more volatile FII inflows. Over the last three years, of the total capital inflows of $120 billion, 61.8 per cent have come from non-FDI sources. According to Morgan Stanley, over the last 12 months, as portfolio equity inflows have slowed, dependence on debt-creating inflows has shot up. The share of debt-creating inflows is expected to rise to 65 per cent in FY2012, from 44 per cent in the 10-year period of FY2001-10. Deutsche Bank’s global research team says capital flow volatility is not only becoming a source of stress to the external account, it’s impacting growth as well. When flows dry up, they impact investment, which, in turn, has adverse implications for growth. Indeed, in recent years, India’s growth trajectory has begun to move hand-in-hand with capital flows. This, ideally, should have been India’s moment, as one fund manager put it, as the world is hungry for growth. But, a spate of scandals, governance deficit and a perennial policy logjam has rendered the country an untenable investment destination. Deutsche Bank believes the low-hanging fruits of reforms from the past decades have largely been harvested and a second reform push is needed to head back to the desired high and stable growth trajectory.

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