Fiis: Like Johnsons Horse

Net private capital flows into the developing countries in 1995 amounted to $166 billion, of which direct and portfolio investment in India accounted for less than $5 billion. The net FII inflow in 1996 into India is estimated at $3 billion.

There is a frequent outcry by vested interests as to the insidious role of FIIs. It is alleged that with their large fund base they are in total control of the market and that they dampen the domestic price of a scrip by selling just before a GDR issue. Again, there is loud wailing that foreign broking firms, with their muscle power, corner a disproportionate share of the market. The Assocham report on foreign investment, however, takes the cake. While welcoming foreign investment, it cautions that FIIs may purchase shares they will also sell shares: ergo, FII funds are hot money; obviously such charges are statistically not substantiated.

 

While not denigrating the fears of Indian industry it must be recognised that the shrill diatribe against FIIs is not only unwarranted but is clearly against Indias interest. The ambivalence towards FII investment while welcoming direct investment is akin to being extremely cordial to a house guest in the parlour while expressing open hostility when he enters the verandah. Our uncanny ability of shooting ourselves in the navel needs to be curbed and puerile articulation against FIIs effectively countered. The most important issue is the question of FII investment being hot money. It is the duty of FII to invest in well-run companies and to exit from poor performers. After all, is this also not the duty of every other institution entrusted with the investors money? The track record of FIIs is precisely to maintain the quality of their investment by shuffling their portfolio, while their overall level of investment is governed by whether or not Indias macro-economic policies are sound. Thus, instead of

crying foul at each action of an FII, we should concentrate our energies on maintaining sound macro-economic policies.

The opening up of the debt market to 100 per cent FII debt funds and the more recent opening up of the government securities market to FIIs is a landmark policy change which will provide considerable depth to the gilt market. It has been widely known that there are a number of FII debt funds whose central interest is the gilt market, and by denying access to FIIs we in India were so far punishing ourselves. The euphoria, however, needs to be tempered as FII investment in the government securities market will take place only gradually. It would be of immense benefit to the gilt market if certain issues are clarified very quickly. First, it needs to be clarified that FIIs would be allowed to operate in both the primary and secondary markets. Secondly, the Sebi release indicates that FIIs can invest only in government dated securities. There would be considerable FII interest in treasury bills, the benefit of which the government is denying itself. Moreover some dated securities in the secondary market would have less than one year maturity and as such the intent of the restriction would not be fulfilled. Thirdly, the governments insistence of a tax deduction at source (TDS) of 23.1125 per cent on government securities has given rise to the peculiar animal called voucher trading which distorts market prices of securities. Time and again, it has been cogently argued that the TDS should be done away with for gilts. Fourthly, the withholding tax on FIIs, income is anomalous when considering that external commercial borrowing (ECB) is not subject to any such tax. Furthermore, it is not clear how FIIs investments in gilts would be monitored in relation to the ECB ceiling. Finally, 100 per cent debt funds should be allowed to cover themselves in the forward exchange market. This is necessary if FII funds are to enter the debt market in a big way. This measure would be a first step in genuinely integrating domestic and international financial markets and this will bring about greater efficiency of financial operations.

The time is apposite to remove these procedural cobwebs.

The attempt to streamline procedures for registration and investments by FIIs, would greatly encourage such flows in India. After all the larger the number of funds the greater the variation in FII investor perceptions on the country. Advisers to FIIs admittedly use sophisticated techniques of risk evaluation but each adviser appears to have his own perception which varies widely from those of others but then this is what the market is all about. For instance ING Barings and Morgan Stanley appear bearish about India, while Merrill Lynch and BZW give a very favourable macro-economic risk evaluation for India; admittedly, each assessment has its qualifying riders. Nonetheless we in India do not have to be hyper-sensitive to individual evaluations.

There is, however, an anomaly in the information on FII stake in India. The present concept of net inflows does not capture the countrys liabilities. To assess this, it would be necessary to obtain from FIIs the value of investments as on say March 31, of each year. Over time, the outstanding value of investments would be very different from outstandings derived from net inflows.

The important point from Indias long-term interest is to recognise that there is no substitute for prudent macro-economic management and such sound policies will pave the way for long-term stable FII investment in India. Thus, early correction of deviations from the desired objective of macro-economic stability will require less drastic policy corrections and this would instil greater confidence in our policies. With a sound macro-economic framework there would be large FII inflow and it would be desirable to evolve suitable instruments to ensure efficient sterilisation of the inflows and an appropriate exchange rate policy.

Ultimately, we must make up our mind whether we wish to welcome FIIs and if we do we should eschew from paranoid responses. The FIIs are rather like Dr Samuel Johnsons horse: The surprise Sir, is not that it wants to stay but that it stays at all.