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Capital Inflows - Rallying stock markets due to

hot money Inflows

Rising India

India has become one of the most preferred investment destinations and is
gaining more and more acceptance with each passing day. India is now seeing
inflows from all corners of the globe, be it global macro funds, hedge funds or
exchange-traded funds. India's rise has not only made investors across the globe
happy but has also been acknowledged by the 'Global Governance 2025' jointly
issued by the National Intelligence Council (NIC) of the US and the European
Union's Institute for Security Studies (EUISS) ranking India as the third most
powerful country in the world after the US and China and the fourth most
powerful bloc after the US, China and the European Union.

Why are Foreign Institution Investors (FII) investing in India

The main reason why Foreign Institution Investors are parking their funds in India
is because currently India has got the ability to produce goods and provide
services at low cost. The employment opportunities in India, where they a few
jobs and a larger pool of qualified and professional work force has created a
situation where industries can easily hire a well qualified or even an over
qualified professional at a lower cost, usually at a fraction of international wage
standards. In developed countries getting good service from well qualified
professionals can be a significant burden on their budget. So staffing cost affect
the profitability and the survival of these foreign companies. If a company does
not control their cost then they will probably not survive, especially because their
competitors might already be outsourcing in India to save costs.

In India, there are so many qualified people, competing for good jobs. Pay scales
provided by the foreign companies might be much less than their domestic rate,
but even this lower salary is well accepted by the Indian counterpart because of
the lower living costs in India and the currency exchange rates. If you post a
single job, it is common to get a list of at least 100 candidates, each of them
almost equally well qualified. As such the scarcity of employment opportunities
brings good competition in the labour force and automatically improves the
quality and productivity which is highly favorable for foreign corporations.

Labour costs in India rise each year and in some fields like software, people feel
that they will no longer experience double digit salary increases anymore. This is
important to protect the costs benefits and continue to attract Foreign
Institutional Investors to India. This is the reason why Industries like BPO, IT and
Manufacturing are steadily rising in India.
Majority of all the big companies of the world have their presence in India in
some way or the other and many of those which don’t have their presence are in
the process of extending their presence in India. Some companies outsource
their accounting and other outsource their IT and BPO operations. Regardless of
the domestic issues, they get excellent value and service for their money.

The Indian policy changes in February 2005 that allows foreign investment of up
to 100% in construction development projects with fast-track approvals. The real
attraction is investment returns of potentially 25% and more in Indian projects
that might be hard to come by today in the U.S. and Western Europe. India's
urban office space market is tiny at compared with New York City's 400 million
sq. ft. or New Jersey's 175 million sq. ft

Also, foreign investors are moving money to Indian markets to take advantage of
a growing gap between near-zero interest rates in United States and Japan, and
rising rates in India. Benchmark rate set by Reserve Bank of India which
currently stands at 6 percent is quite high when compared to the interest rates
offered by the developed economies like United States of America and Japan. If
the difference between the rates grows in future, the traders can make more
money by borrowing cheaply in dollars and yen and investing that money in
higher yielding stocks and bonds in India.

FII's Pumping in Huge Money

Two years ago, when the crisis on Wall Street reached its pinnacle, the high-
flying Indian stock market fell like a stack of cards as foreign investors took
nearly $5 billion out of the country.

The situation is very different today. At the start of the calendar year 2010,
Sensex was perched at 17,500 levels. Since then, inflows from FIIs has crossed
the magical Rs.1 lakh crore mark, an achievement by no means less than a gold
medal for the Indian stock markets and clearly a sign of confidence among the
global funds in the India Growth story. In September alone this year, foreign
investors poured $7.1 billion into Indian stocks and bonds, a monthly record for
foreign investment in India’s securities market.

This gush of investment wind has taken the benchmark Sensex past 20,000
levels, which sums up to a decent 15% rally since the start of the year. In the
first seven months of 2010, foreign institutional investors have poured
approximately $11 billion into Indian equities (see chart below), compared with
about $7.5 billion during the same period last year. FIIs have also broken all
previous records by committing in excess of $18 billion, or Rs 84,000 crore (Rs
840 billion), in Indian markets in a single calendar year, though we still have a
full quarter to go in 2010, hence inflows this year are expected to rise further.
Because of this huge FII inflow Indian rupee has appreciated about 4 percent
against the dollar so far this year.
Advantage of a developing Economy

The major stock exchanges appear to be at a high as they set in early 2008,
when many analysts argued that many fast growing developing countries are
decoupling from the developed world.

Same is the scenario in the current day as Indian markets give signs of
decoupling.

Developed economies like the United States, along with much of Europe and
Japan, may stay in the economic doldrums for some time but the problems in
developed economies could benefit emerging nations like India, as Western
hedge funds, banks and other investors hunt for growth opportunities. The rest
of the world is starved for growth but India is still producing relatively high real
rates of G.D.P. growth. With an economic growth rate of around 9 percent, India
is a preferred destination even compared to its competitor China for foreign
investments as Indian markets are more open to foreign investor in comparison
to Chinese markets. The strength of the market has been a boon for Indian
companies, as well as the Indian government, which has been selling shares in
state-owned firms.

FII Contradiction

Indian stock market may be getting dangerously frothy as huge foreign portfolio
investment into India has helped push both the stock market and the rupee to
pre-crisis levels. India’s emerging market peers, including Brazil, Indonesia,
South Korea, Taiwan and Thailand, have taken some measures to curb foreign
capital inflows and are acting to suppress resulting currency appreciations.

This fear is much seen among the Indian individual investors, burned by the
2008 crash, as against the foreign money managers. As a result of the huge
amounts of cash flowing from developed countries into India, the Indian rupee
has appreciated which has posed a threat to the Indian exporters as their
exports are becoming less competitive. Software services have, particularly,
seen their competitiveness suffer. Importers of goods and services may have
benefited because of the decline in the rupee value of goods and services
imported. But this can lead to protests by competing Indian manufacturers
located in India. The Government has responded somewhat at reluctantly by
offering a package of tax incentive and interest reductions to exporters.

The increasing bullishness about the Indian markets is sending the stocks to
dizzying heights that may not be justified, even in light of the country’s high
growth rate, which some expect to slow somewhat in the coming months. There
is also a risk that foreign investors in India could suddenly decide to withdraw
their money, as they did in 2008, if the Indian economy slows or if global
markets rattle by another crisis. That reversal could then pull down real
economic growth in India by depriving the country of capital.

For example, in 2008, India’s growth rate fell to 6.7 percent, from 9.2 percent,
partly because foreign investors took billions of dollars out of Indian stocks and
bonds and slowed down new investments. The slowdown severely hit real estate
developers, airlines and other companies with large capital requirements.

Another concern is that with a surge in net capital inflows through increased
foreign portfolio investment, managing these volatile capital inflows is back on
the policy agenda. Challenge lies in finding out which policy choices would help
India to minimize the costs of volatile capital flows. Majority of the foreign money
flooding into India is going into the stock market, rather than into new projects
and start-up companies. While flows into the stock market have more than
doubled, foreign direct investment into India fell more than 24 percent in the first
seven months of the year, to $12.5 billion, compared with the comparable period
a year earlier.

Unlike holdings in the stock market, which can be sold quickly when traders in
London or New York get nervous, direct investments in factories, stores and
companies are harder to sell and are usually held for longer periods.

Cash inflow might be interpreted as a revival of confidence in the Indian market,


but this quick inflow of cash, along with short-term foreign currency borrowings
of Indian banks, represents the most volatile component of capital inflows into
India.

Some skeptics believe that investors appear to be ignoring the lessons of the
recent financial crisis, which did not remain confined to the developed world.

Flurry of IPOs in the Equity Markets

2010 can be remembered as a year of record issuances in the primary markets.


FIIs with their US$ 20 bn of investments have been key contributors to supply of
funds in Indian stock markets this year.

Buoyancy across sectors and market caps has led promoters of several small and
midsized companies to cash in their stakes. And investors in the IPOs too have
had more winners than losers in the short term.

Out of the 42 stocks that debuted on the bourses in 2010, 18 have locked in
gains in the range of 20% to 233% till date. In 2010 so far Indian corporate have
raised over Rs 500 bn through domestic issues. This is close to the amount
raised in the whole of 2007. In fact the oversubscription levels for recent IPOs
suggest that appetite for such issues is a lot higher.

And the pipeline is far from drying up. The government's US$ 10 bn
disinvestment programme has a lot of ground to cover up. Coal India's IPO
targeting to raise Rs 160 bn is slated to be the biggest ever public issue in the
country till date. Including the companies that are waiting in the wings with their
offerings. They are expected to raise around Rs 770 bn from the primary market.
Coal India's issue in October will make the total mobilization that month higher
than that during the whole of 2009.
Below is the list of some of the Recently launched IPOs

Issuer Company Issue Open

Gyscoal Alloys Ltd IPO Oct 13,


2010
Prestige Estates Oct 12,
Projects Ltd IPO 2010
BS Transcomm Ltd IPO Oct 06,
2010
Oberoi Realty Limited Oct 06,
IPO 2010
Commercial Engineers Sep 30,
& Body Builders Co Ltd 2010
IPO
Bedmutha Industries Sep 28,
Ltd IPO 2010
Sea TV Network Ltd Sep 27,
IPO 2010
Ashoka Buildcon Sep 24,
Limited IPO 2010
Tecpro Systems Ltd Sep 23,
IPO 2010
VA Tech Wabag Sep 22,
Limited IPO 2010
Cantabil Retail India Sep 22,
Limited IPO 2010
Gallantt Ispat Ltd IPO Sep 22,
2010
Electrosteel Integrated Sep 21,
Limited IPO 2010
Orient Green Power Sep 21,
Company Ltd IPO 2010
Ramky Infrastructure Sep 21,
Limited IPO 2010
Microsec Financial Sep 17,
Services Ltd IPO 2010
Eros International Sep 17,
Media Limited IPO 2010
Career Point Sep 16,
Infosystems Ltd IPO 2010
Tirupati Inks Limited Sep 14,
FPO 2010
Indosolar Limited IPO Sep 13,
2010
Hot or Not
Now all investments coming into Indian equity market are not necessarily bad or
volatile. On the other hand investments give Indian companies money for further
investment. Stock market has surged at the backdrop of strong rural
consumptions, stable government and good monsoon.

All emerging countries have experienced both currency appreciation and stock
market upward movement in recent past. Table 1 shows change in currency
value and related stock index movement of emerging market economies In case
of China currency appreciation has been as China allowed currency to
appreciate abolishing a pegged exchange rate regime. So India is not alone so
far hot money destination is concerned.

Table 1

Countr Curre Mar Sept Mar- Sep-


y ncy '10* '10** Stock Index 10 10
Brazil Real 24.6 5.4 Bovespa 71.9 0.3
Shanghai
China Yuan 0.14 2 Composite 31 3.6
India Rupee 12.9 1.4 BSE Sensex 80.5 14.5
Indones Jakarta
ia Rupiah 27 2.1 Composite 93.7 30.5
Malaysi
a Ringgit 11.4 5.3 KLSI 51.3 13.5
Thailan
d Baht 9.8 7.9 SET Composite 82.6 24.9
Russia Ruble 14.9 -3.5 RTS 128 0.7
Source- Macroeconomic& Monetary Development Second Quarter
Review, RBI
* Year on
variation ** Variation over March'10

Stable FII inflows which are long term in nature are healthy for the economy. But
short term investments by hedge funds could be highly speculative. Participatory
Notes (PN) is a vehicle used for speculative investments. Portfolio investments
can be done by participatory notes. For participatory notes the nature of buyer is
unknown and in many cases buyers are various FIIs which have been banned by
RBI. To increase foreign investments Indian government has allowed investments
through participatory notes. Investments through PNs have come down
drastically. Figure 2 shows investment through PN as a percentage of assets
under management of FII (Source SEBI). It can be seen that PN has come down
to around 15% from around 50% in 2007.

Figure 1

References
National Stock Exchange. (n.d.). Retrieved November 2, 2010, from
http://www.nseindia.com/
RBI. (2010).

Macroeconomic and Monetary Development: Second Quarter Review.


SEBI. (n.d.). Retrieved November 2, 2010, from http://www.sebi.gov.in/Index.jsp?
contentDisp=Database

Timeline of International Trade-Wikipedia. (n.d.). Retrieved November 2, 2010,


from Wikipedia: http://en.wikipedia.org/wiki/Timeline_of_international_trade

Yahoo Finance. (n.d.). Retrieved November 02, 2010, from


http://in.finance.yahoo.com/q/hp?s=^BSESN

http://www.thehindubusinessline.com/2010/09/18/stories/2010091852900100.ht
m

http://www.businessworld.in/bw/2010_09_20_Busiest_Week_For_IPO_Market_In_1
5_Years.html

http://www.expressindia.com/latest-news/IPO-market-back-in-the-spotlight-
again/692018/

http://www.rbi.com