Are Foreign Investments driving the Indian Stock Market?

Ubaid Parkar

The Indian stock markets will be forever etched in volatility. Not so much would it be unpredictable due to numerous variables that this country has to offer but due to one major altering element, Foreign Institutional Investment (FII). Property developers and buyers swear by the rise and fall in stock prices. Developers moan about liquidity crunch whereas buyers exercise caution driving down sales.

Herding, wherein FII’s tend to buy and sell stocks in bulk, tend to create major withdrawal effects when they leave. This has been coined, albeit inappropriately, as ‘hot money’ given the tendency of such flows to suddenly reverse direction in response to adverse market sentiments and precipitating large capital outflows.

These actions do not provide that stability in the stock market and has a high probability of skyrocketing one day and falling over like a stack of mounted coins piled by a four year old on another. Other countries have fixed quotas and ceilings for FII inflows.

In 2008, during the deepening of the impact of the global recession, over Rs 11,000 crore was pulled out from the Indian stock markets. From the dizzying heights of the 20,000 mark, it crashed down to 12,000. The major cause of this crash was attributed to the recession in the global economies, especially with the US dollar losing its strength to the Indian rupee. The US credit card economy was in debt and hence had to recall capital from foreign markets.

Dr Ranjit Pattnaik, Consultant Economics said, “The FIIs withdrew earlier due to a financial deficit in their respective countries. It does not necessarily mean that it is a false indicator of the status of the global economy, of which India is a part of.”

FII inflows crossed the Rs 60,000 crore mark last month. This means India may be back on the run. “The money has now come back. The stock market behavior is dependant on many fundamental factors and FIIs are not the only factor. The entry of FIIs gives a positive impact on the stock market. Foreign investments will come if the returns and risks are well managed. And India’s risks and returns on the returns on investment are indeed well managed,” added Dr Pattnaik.

Experts said that the recession did not really run aground on the coastal city of Mumbai. The local effect was felt in trade and retail. So do we have a disjointed indicator to broadly generalize the state of the Indian economy and its sentiments? There is another view. It has been reported that over the past year that Domestic Institutional Investors (DIIs) including mutual funds, banks and insurance companies have been instrumental as the mainstay of the secondary market. But it does not dismiss the instability of massive withdrawals from FIIs.

Now since we are connected to the global economy we may have to consider, say for instance, the US economy. The US has had massive government spending but consumers are not in the spending mood and unemployment rate in the first week of November is a whopping 10.2 per cent. Some experts point to stabilization in the housing and job markets as signs that the recession has ended. Others continue to see weeds; not green shoots. A jump in stocks poses a chicken-versus-egg question.

An economic pessimist would remind you of a Double Dip Recession (recession followed by a short-lived recovery, followed by another recession). Then there is a Triple Dip too. Moreover the GDP recovery was “bought” by the federal government’s $787 billion spending package. “The World Economic Outlook (October 2009) by the International Monetary Fund (IMF) has revised GDP Growth to positive figures for 2010. There are signs of recovery. The only question is the time factor. How quickly will the recovery come around is anyone’s guess,” opined Dr Pattnaik.

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