Foreign inflows in debt zoom to a record high

Previous peak in 2010 crossed in first five-and-a-half months this year

Foreign institutional investors (FIIs) bought debt instruments worth a little over $10.5 billion in 2014, beating the previous high of $10.13 billion in 2010. There was a sell-off last year, as FIIs pulled out nearly $8 billion from the corporate and government bond markets in 2013.

India has received around $36 billion worth of capital inflow in the year so far, with the bulk coming over the past three months. Of this, portfolio investment in debt and equity was $20.4 billion and foreign direct investment around $8.5 billion.

Experts attribute the flows to a mix of higher interest rates in India, cheap capital in developed markets and foreign investors' preference for high-yielding assets in emerging markets. "Libor (London interbank offered rate) has fallen to a 40-year low of 0.5 per cent, drastically reducing the cost of taking risk. The result is a scramble among foreign investors for riskier but high-yielding assets in emerging markets, including India," said Deep Narayan Mukherjee, director of ratings at India Ratings.

Capital flows into India were amplified by geopolitical troubles in Ukraine and Russia and concerns about China's growth rate. "Capital that would have gone to Russia and China in the normal course found its way into the Indian debt and equity markets, given the size of our economy compared with competing countries like Brazil, Indonesia, South Africa and Turkey," Mukherjee added.

According to the Securities and Exchange Board of India (Sebi), FIIs bought shares worth $9.9 billion in 2014, in line with $20 billion invested by them in the same period last year. Nine companies have together raised nearly $5 billion through bonds abroad, according to Prime Database.

Besides, companies raised around Rs 11,500 crore (approximately $2 billion) through four qualified institutional placements (QIPs) of shares till May, much higher than Rs 8,000 crore raised through 10 QIPs during all of 2013. The bulk of the QIPs were picked up by foreign investors. This includes $500 million raised by YES Bank and Idea Cellular each, but excludes stake sales by promoters in Kotak Mahindra Bank to the Canadian Pension Plan Board worth around $370 billion.

FDI inflow was at a steady pace, with multinationals investing nearly $6.25 billion in March and April, according to the Reserve Bank of India. The April inflow of $2.6 billion was in line with FDI worth $36 billion during the year ended March 2014.

Experts said inflows would remain healthy so long as liquidity is easy in Europe and North America and India's macroeconomic indicators stay stable. Last week's sell-off on Dalal Street and a depreciation of the rupee over the Iraq crisis, however, indicate the fragility of this cycle. "Any external shock could lead to a sell-off by foreign investors as we saw early this week. Economic conditions are much worse than what indices show," said Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

The other risk is a likely rise in Libor. In the early 2000s, the one-year Libor was around two per cent and it climbed to six per cent in late 2007 and early 2008, setting the stage for a financial crisis and a global sell-off in equities. "Libor is sure to rise. It could start happening this year or in 2015 or 2016. When it rises, it will lead to capital flows and a sharp depreciation in the rupee," said Mukherjee of India Ratings.

The bad news is, however, too far into the future for Dalal Street to worry about. The stock market could scale new highs before correcting meaningfully.