Has the Indian economy taken the worst brunt of massive capital flight by foreign investors?

In a Bloomberg Online article published on July 16, 2013, it was reported that the Indian stock market (the Sensex) slid by approximately 1.3 percent to 19,771.18 as of 0930 hrs (Mumbai time), as the effects of the latest interest rate hikes are being felt. These latest rounds of interest rate hikes are being issued by the Reserve Bank of India (RBI) aimed at stemming the flow of capital flight out of the country.

The Bloomberg article mentioned that on July 15, the RBI increased the marginal standing facility and the bank rate to 10.25 percent from 8.25 percent, and plans to auction USD 2.0 billion of government bonds on July 18, moves which suggest that the government intends to tighten liquidity, and seeks to stabilise the value of the Indian Rupee currency, which has been weakening throughout the past few months against the US Dollar. The Indian Rupee has weakened to approximately 8.2 percent against the US Dollar, hurt by the slowest growth in a decade and the massive current account deficit. In a semi-annual world economic outlook issued by both the International Monetary Fund (IMF) and the World Bank, the range of forecasts for Gross Domestic Product (GDP) growth for India is approximately between 5.0 to 6.0 percent, a contrast to the current 2Q13 GDP growth for China, which officially stood at 7.5 percent based on the latest Chinese government figures on July 15.

The latest round of interest rate hikes are closely watched as the country takes the necessary steps to stem the tide of foreign capital outflows seen recently, and part of the so-called ‘hot’ money seeking for safe-haven countries as a result of the expected unwinding of the global monetary stimulus by many Central Banks, including the US Federal Reserve, where many analysts have pointed to possible tapering moves to take effect by the end of 2013, and early next year. This exodus of foreign capital flows also serves as an indication of the extent of unwinding of carry-trades have on emerging countries’ balance of payments (BOP), and implications , both short-term and long-term they have on the value of the local currencies.

India is not alone in stemming massive capital flows, but is a cause of concern among many investors, and policy makers regarding its structural imbalances which came about as a result of the instability of the Indian government as issues such as population control measures, social tensions caused by religious divide, massive corruption issues remained unresolved, poor infrastructure, health-care and education facilities that should have been provided in order to spur growth and foreign direct investments (FDI) into the country, etc. According to the same Bloomberg article, it was reported that the country’s wholesale price index increased by approximately 4.86 percent in June from a year later, compared to 4.70 percent in May. The median estimate of 30 analysts surveyed by Bloomberg was 4.94 percent, and is quite close to the actual published numbers. Retail price inflation rose to 9.87 percent in June from 9.31 percent in May, while factory output unexpectedly declined during the month of May. This latest set of statistical data closely reminiscent a stagflation-like environment where production slows down, but prices at both the wholesale and retail levels rise.

The question is whether RBI has poorly timed its intervention in the market at a time where global markets are still quite volatile, and investors have not yet figured out the monetary policy directions undertaken by major central banks, especially the US Fed, where Chairman Bernanke did not explicitly provide a timeline on the unwinding of the monetary stimulus, except to say that such moves are quoted as being “data dependent”.

As for the RBI and their monetary policy moves this year, Governor Duvvuri Subarro has so left interest rate unchanged in June for the first time in four policy reviews, citing inflation risks. The next policy meeting is expected to take place on July 30, where it could be an opportunity for investors to examine the direction of future policy moves undertaken by the RBI in stemming the ongoing capital flight.

However, the larger issue, apart from the financial implications, remains to be on structural initiatives that might have lessen the blow from the massive capital exodus by global investors, which have so far sold approximately USD 220.0 million worth of local equity on July 11, with International funds selling approximately $1.8 billion in June, which was the most since August 2011. The Congress Party-led minority government is increasingly showing signs of losing its electoral support for its leader, Prime Minister Mahomman Singh due to the various internal strife taking place, and weak government policies that not only resulted in widespread discontent among the Indian people, but also led to the current economic weakness seen in the country.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc