Ignominy Of Indian Investment

Half a dozen foreign fund managers hold the key to the Indian markets in the coming days, even months. Of the total $8 billion invested in Indian equities, more than 50 per cent are held by various funds of Morgan Stanley, Capital Inter-national, Schroeders, Jardine Fleming, Government of Singapore, Alliance Capital and Templeton.

If these funds decided in unison to sell their Indian holdings, not even the Unit Trust of India (UTI) with its deep pockets which hold over Rs 1,000 crore will be unable to stem the fall. This concentration of Indian holding makes the market even more volatile in the coming months. If just one of these funds decide to cut its exposures down dramatically -- not the staggered selling seen in the past week -- it could spell serious trouble for the market.

 

This time around, the UTI has been able to stop the slide but brokerage houses selling this market are quickly running out of sales pitches for the Indian market. Forget getting people to buy more, the question is can you stop them from selling. And why shouldn't the FIIs sell?

Five years of investment have hardly earned them the level of returns that enticed them here in the first place. If emerging markets are meant to give extraordinary returns because of the extra risks, India has been the exception to this rule. Instead, the rupee has fallen from Rs 31 to Rs 42 against the dollar and capital gains, if any, have been wiped out by currency depreciation losses.

Instead of having benefited from owning a piece of one of the "great markets of the future", foreign institutional investors (FIIs) now hold equity in a sub-continent that it becoming volatile, and jingoistic; a place where economic reforms and liberalisation have given way to protection and inward-looking economic policies.

Zoom out a bit more and the bigger picture looks even worse. Troubles in Southeast Asia are continuing. The economies still need another 18 to 24 months to get back on track. The result: investors are reducing their exposures across the board in Asia; dragging markets down as they force their fund managers to sell.

Zoom in now to focus on this country itself. Till the nukes blew and the government blew its chance in the budget, brokerage houses were selling India as a safe port to harbour in the Asian storm. Now even that hope seems remote. Discretionary funds, which landed here, have taken off just as quickly. And it's not difficult to see why.

Without any major policy initiatives to prove to foreigners that the thrust of reforms will be carried forward, there really seems to be little upside for investors. And in the absence of good, improving corporate sector results, the only upside for investors would have come from a re-rating of the market. That is not likely to happen now with the reforms not really being extended strenuously. Besides, with liquidity expected to tighten in the coming months, the possibility of higher interest rates and a falling rupee, it is understandable why foreign investors have little interest in looking at fresh investments in the Indian markets.

Add to that a fickle coalition which is not being allowed to function properly either by vested interests within the party which insist on a greater swadeshi approach and the motley crew of alliance partners who seem to care less about the government and more about their personal battles. From an outsider's point of view, stable one-party governments have now given way to mix-and-match coalitions, which only add up to slower reforms and higher political risk.

Higher political risk is also translating into slower reform. The withdrawal of the urea price hike and the dilution of the power bill does little to boost investor confidence. The result is that no one really believes the finance minister and his boys when they appear all over television justifying their optimistic revenue assumptions. (Wonder when the MTV interview is scheduled?)

And however helpful the non-resident Indian (NRI) may mean to be, it is unlikely that this bunch will be able to bring in the amounts that FIIs can. The UTI, for instance, is hoping to collect only about $600 million from its Millennium Fund. The State Bank of India is already talking about losing FCNR deposits when the Resurgent Bond is launched.

These amounts may not boost either the market or the foreign exchange reserves significantly but there is no need to fear a complete sell-off from FIIs. The saving grace for the Indian markets may be that large chunks of foreign money is invested through dedicated country funds which have little option but to stay on. For those still invested in the market, the downside may not be much from the current levels.

But the crucial question is: Where will the upside come from? This is one question investors keep asking and nobody has an answer.