India: Equity market liberalization fails to excite

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By:
Elliot Wilson
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Opening for foreign investors will have only long-term effects; QFIs force for stability

Even a couple of years ago, India’s snap decision in January to permit foreigners to invest directly in the country’s stumbling stock markets would have made headlines around the world. Instead it was greeted with apathy. With India’s markets at multi-year lows and leading corporates weighed down by inflation, high interest rates, a weakened rupee and worrying dollar debts, the development passed most people by. Even India’s financial media, usually frothy with excitement over a hot stock or a regulatory sweetener, barely broke sweat. Long-term benefits Yet, analysts say, the ruling, finalized on January 15, might do much good in the longer term for India’s embattled bourses. It will permit qualified foreign investors (QFIs) to invest directly in Indian stocks – helping, in theory, to attract more foreign funds and higher-income retail investors, adding depth and breadth to the local markets. Before the rule change only locally-born or non-resident Indians could buy domestic listed shares at the retail level. Non-Indians were restricted to buying shares via funds registered as ‘foreign institutional investors’. These FIIs have in recent years become immensely, if unwittingly, powerful. Many see them as among the most powerful determining forces on India’s bourses – and even a de facto collective bellwether stock. When FIIs buy, retail and institutional Indian investors buy. When they sell, so does everyone else.
It is hoped that opening India’s stock markets to qualified foreign investors will revitalize them
The new ruling was rushed through by India’s enfeebled premier, Manmohan Singh, for two reasons, neither of which much involves the actual interests of foreign investors. First, foreign direct investment. Singh and his hapless cabinet failed in December to push through a bill designed to permit multi-brand retailers such as Wal-Mart and Tesco to set up their own stores in India. The bill was rolled out on November 24 amid much fanfare, then repealed two weeks later after Singh succumbed to political pressure amid fears that big retailers would squeeze out local mom-and-pop stores. Second, India faces a serious budgetary crisis. It runs the only current-account deficit in Asia. Morgan Stanley chief Asia Pacific economist Chetan Ahya tips the nation’s consolidated fiscal deficit to come in at 8.3% of GDP in the financial year to March 31. Hence the January ruling on retail investors: designed, India’s foreign ministry said, to “widen the class of investors, attract more foreign funds, and reduce market volatility”. There is also a feeling in India among regulators and legislators that retail investors might prove to be acceptably stable investment partners. “The finance ministry and the Reserve Bank of India view retail money as being better long-term bets compared with FII money, which is herd money,” says Deepak Lalwani, founder of London-based, India-focused brokerage Lalcap. FIIs are of course fair-weather friends, in India and elsewhere – that is the nature of the beast. Foreign institutions pumped a net Rs1.33 trillion ($27 billion) into Indian stocks in 2010, and Rs830 billion the year before. But net outflows of Rs71 billion in 2008 and Rs2.8 billion in 2011 (including a record monthly outflow of Rs11 billion in August of last year) paint foreign funds in India as hokey-cokey institutions with a tendency to dip in and out of the market at will. There is no certainty that the move will succeed. Retail investors rarely invest in stocks based in another country, just as few consumers buy products shipped in from another country. Just the start If anything, this will be only the start of an incremental building process that is unlikely to generate much short-term capital for India’s depleted coffers. “It won’t be a game changer,” says Sreesankar Radhakrishnan, head of institutional equities at Tata Securities. “But it should be a sentiment booster.” Lalcap’s Lalwani concurs, noting: “In the short term I don’t expect sizeable amounts [of QFI] capital to flood in, but it will build up over the next year or two as interest rates fall. This is really more of a move to attract the more sophisticated and affluent retail investor, the type of person who already knows the big names on the Indian stock markets.” Analysts say the stocks most likely to win are corporates with global reach or regional prominence, from lenders ICICI and HDFC to conglomerates such as Reliance and Tata.

Indian stock watchers, for now, are keeping a hawkish eye on the January ruling’s fine print. Indian regulators have an unfortunate reputation for announcing grand designs – then swathing them in red tape when they think no one is looking. “Opening up this sector will help [India’s stock markets, but it depends how onerous the bureaucracy will be,” says Lalwani. “As ever in India, the devil is in the detail.”