No new enterprises

Global investors still bullish on India, but are constrained

The continued strength of the Indian stock market - the Sensex is staying close to historic highs - has led much attention to focus on the role of foreign money, particularly inflows from foreign institutional investors (FIIs), in driving up local stock prices. Over the past fortnight, FIIs have pumped in over Rs 7,500 crore; by most accounts, domestic investors are happy to sell shares at the prices that foreigners are willing to pay. To a casual observer, it might appear that there is renewed confidence in the fundamentals of the Indian economy on the part of foreign investors. It is far from certain whether that is an accurate reflection of what is happening, however. In fact, it is more likely that the temporary spurt in global liquidity following the decision by the United States Federal Reserve to postpone the "tapering" of its quantitative easing programme is at work. Global exchange-traded funds are once again looking outside the US in search of short-term returns. Further, the concentration of recent stock-market buying in interest rate-sensitive sectors, such as banking and capital goods, indicates that when the tide turns, with the Reserve Bank of India perhaps raising rates and liquidity drying up in the US, this short-term money could vanish in a hurry.

The artificial highs of the stock market indices at a time when faith in the real economy's immediate prospects is at a low is another indication that a dependence on FIIs can lead to disaster. Far better for India would be sustained foreign direct investment, or FDI, which would permit solid investment in real productive capacity, especially when invested in equity of new projects. The general impression is that FDI in terms of equity inflows has slowed down, or is at least dwarfed by FII flows. However, the numbers do not confirm that impression. In 2012 calendar year, FDI equity inflow into India was $22.8 billion; net FII flows into India were $24.5 billion. Very much in the same ballpark. And, for 2013 till July, the position changed: for FDI, $12.5 billion; for FIIs, $12.2 billion. In other words, FDI is holding its own; investors' interest in the real productive capacity of the Indian economy has not vanished, even as global finance seeks short-term returns in its markets. In fact, in the last month for which figures are available - July 2013 - FDI equity inflows jumped by 15 per cent when measured in US dollars. Overall, in the first seven months of the year, FDI equity inflows in dollars were 6.7 per cent more than in the equivalent months of last year. India is still, according to these numbers, a worthwhile place to invest.

However, it is important to look at the stories behind the numbers, too. For example, one big contributor to the figures for July might well have been the Anglo-Dutch consumer-goods giant Unilever, which decided to up its stake in Hindustan Unilever to 67 per cent. Other multinationals, too, such as GlaxoSmithKline, have done the same, or taken subsidiaries private. The flow of investment into new enterprises, however, as opposed to existing enterprises, has been hit by several high-profile failures, such as Posco's Karnataka steel plant and ArcelorMittal's in Odisha. The lesson? It is difficult to start new business in India. If this government or the next could address that head-on, they would not have to make the very risky bet on hot money supporting Indian markets and the current-account deficit.