There is an old adage that bull markets climb a wall of worry but having climbed one wall, it is the nature of markets to worry about the next one.
It is sometimes instructive to think back about the walls that were encountered in the past and how they were scaled.
A formidable one that the Indian markets faced in recent times was post what is now called taper tantrum in 2013. With high current account and fiscal deficits, India was clubbed with four other such emerging markets into the infamous Fragile Five. Two years later, it is now consensus opinion that India is out of that club and better prepared to deal with the situation as and when the U.S. Federal Reserve decides to hike interest rates.
Indeed, India’s Current Account Deficit, or CAD, has shrunk from 4.7% of GDP in F2013 to 1.4% last year, by far the best adjustment amongst the Fragile Five countries. What is even more heartening is the fact that India’s dependence on volatile portfolio flows to fund her CAD has reduced. Net Foreign Direct Investments, or FDI, exceeded the CAD for the first time since F2008, signifying that the deficit is now funded with stickier capital. The improvement in FDI is noteworthy with UNCTAD estimating that India jumped six ranks to ninth position in 2014 in the FDI league tables.
Apart from the increase in quantum of FDI, both absolute and as a share of GDP, we found a few other trends interesting.
One, the investments have been granular and well spread across many sectors unlike some of the earlier years when a few deals accounted for bulk of the inflows, raising questions over sustainability of flows.
Two, net outward FDI (i.e. Indian investments overseas) has reduced to a trickle. From a peak of $19.4 billion in F2009, this has slowed to a mere $1.8 billion in F2015. It is difficult to attribute this to a single factor but overseas misadventures of large Indian corporates of the last few years still seem to be weighing on India Inc.’s mind. This is important because India has had higher absolute Gross Inward FDI in the past, but the net number was lower due to a large quantum of outward flow.
Data for sectoral break-up of FDI is available only for the equity component of gross inward flow. Of the $44.3 billion of gross inward FDI in F2015, equity investments accounted for about $32 billion.
The third trend is that the share of infrastructure and real estate within this had fallen to a low of 11.7% in F2013 but retraced towards decadal average of 23.6% in F2015. We think this will be an enduring trend with Indian infrastructure assets like the Dedicated Freight Corridor etc. getting funded through FDI. While this may not be able to fully replace bank funding for infrastructure, it will ease some of the logjam faced in the sector today due to over-leveraged asset developers and capital strapped public sector banks.
Fourth, and possibly the most important trend, is the emergence of a new sector from close to nowhere a few years ago - FDI in e-commerce and internet space. Again aggregate data is hard to come by and sectorally, this gets diffused over many heads but a bottom up analysis of deal sizes in excess of $5 million done last year, adds up to almost $5 billion. Thus almost 20% of the gross inward equity inflows were accounted by this new source. This trend shows no signs of ebbing in the current year with an ever increasing crowd of global tech companies and venture capitalists not wanting to miss the action in the Indian internet sector.
Also, as Farhad Manjoo recently put it in the New York Times, unlike the dot com boom of the nineties when the holy grail for a technology company was to go public with an initial public offering, or IPO, this time around all efforts are being made to not IPO and remain private. This means that tech companies will continue to play in the unlisted space making stickier FDI the only route for foreign participation.
While we are moving towards claiming our rightful share in global FDI, one has to be cognizant of the fact that a lot still needs to be done to make India an attractive destination for sticky foreign capital.
On the World Bank ranking of “Ease of Doing Business”, India slipped two places to a lowly 142 among 189 countries. We compare ourselves with China on many economic parameters but FDI is one area where we should actually try and emulate the Chinese example. For the past two decades, China has, on average, attracted net FDI of over 3% of GDP as against just 0.9% for India.
Today Foxconn Technologies is grabbing the headlines for planning to set up an iPhone manufacturing facility in India but Korean steel maker POSCO whose $12 billon steel plant was India’s single largest FDI proposal managed only a small obituary in the back pages. The feverish debate around investments by Walmart and Ikea in India’s retail space seems to have all but died down and that’s not a good sign. The TINA (There is No Alternative) mindset, that foreigners will invest in India owing to its large market potential regardless of red tape and regulatory hurdles, breeds complacency. It may be too early to celebrate the improving trends in FDI and naive to assume that India has already become the capital destination of choice.
