As in other fields, India's economic policies are often driven by stupid, pointless nationalism. When I was in the finance ministry, we opened the Indian financial markets to foreign portfolio investment; foreign direct investment remained subject to detailed controls. As I argued in this column in Business Standard of 19 December 2000, the official restrictions made no sense; but they continue to this day.
END OF PORTFOLIO INVESTMENT?
India opened up to foreign portfolio investment in
1992. FPI inflows were high – in the neighbourhood of $ 2 billion a year - from
1994 till 1997; then they have been much lower, and more volatile. Analysts, including I, have connected this to events
occurring in India – for instance, the nuclear ceremony of May 1998, the later
outbreaks of Hindu nationalism, etc. Now I have developed doubts about such
Indocentric explanations.
We talk of some $10 billion of portfolio investment
overall. This is the original cost of the investment. The investment that came
in the early years soon lost about half its original cost as stock prices fell
after 1996. By early this year it had more than recouped its losses and gone
into a premium, but since then it has lost some 30 per cent; today its value is
not much above what original cost. This does not mean, of course, that the current
holders of the investments lost or gained the money. Those who bought at the
bottom of the market in 1998 would have made much money; those who bought in
early will have lost money. But any who came in when the investment was made
and stuck on till now would have had a very poor deal. India was not a country
to invest for good, stable returns; and this was clear by 1997.
This has two implications. First, there could not be
an open India mutual fund. There never was one; and if there had been, all the
money in it would have drained out by 1997. India-specific mutual funds could
be only closed ones. Second, closed mutual funds could be started only when
there was a strong inflow of portfolio investment anyway. At such times, buying
into a mutual fund offered risk spreading and obviated the hassles of buying
shares in the Indian markets. UTI floated its fund in 1988, at the top of the
Indian bull market and right at the outset of US investor interest in emerging
markets; at that time, the government did not allow any except its own
daughters to do such a thing. All the rest – Jardine Fleming, Morgan Stanley,
India Magnum Fund – were started in early 1994.
If no India fund has been floated since 1994, who
has been investing in India? It could be more general funds – emerging market
funds or regional or international equity funds. It could also be managed
funds, of which there are thousands round the world. Individual investors are
still banned by the Indian government; but they could have invested by engaging
an investment manager, giving him an institutional name and getting him
registered with the local regulator.
Now consider the accompanying table. It will be
noticed that US investments in new equity are quite volatile; even more
volatile is their share which goes abroad. The bulk of it goes to industrial
countries; developing countries pick up only the dregs. This does not mean that
a single developing country may not attract more. For instance, according to
our government statistics, India received $1.7 billion in 1997, -$0.3 billion in
1998 and $1.5 billion in 1999. The inflows in 1997 and 1998 are very large
compared to new equity flows into emerging markets. This means that most of the
portfolio investment is due to churning of funds – to their transfer from one
country to another, or one industry to another, or both.
Since 1997, there has been virtually no US demand
for fresh emerging market equity. To begin with, this was part of the decline
in foreign portfolio investment; the IT boom made the US market very
attractive, and outflows to other countries fell. Flows to developing countries
virtually ceased, and this was no doubt in part due to the East Asian meltdown.
But the main factor was the lack of US investor interest in the outside world.
However, the current year turns out to be very
interesting. Despite the decline in US stock prices, new equity purchases in
the US are surprisingly high this year. A higher proportion of them is going
abroad; investors are balancing the domestic risks by buying into overseas
markets. But not to emerging markets; they continue to be taboo. Most of the
money is going to Europe, where a long-awaited recovery is believed to be
imminent. Also, European companies have got into US-style restructurings, and
that has bolstered US investors’ confidence in them. Some money has been
trickling into Latin America. But Asia simply does not figure on the American
investor’s horizon. Nor does India.
This experience has a number of lessons. First,
foreign currency closed India funds are a dead duck. If India had a glorious
boom that promised to last ten years, such funds might make sense. Otherwise,
there is simply no market for such funds. This means that portfolio investment
will go only into Indian equities.
Second, portfolio investment will flow in when India
looks better than other developing countries, and vice versa. Note the word
better; it is not good. What matters is how India compares with the rest of the
world. And the comparison involves not only the quality of Indian companies and
government, but also expected changes in exchange rates and phases of national
trade cycles.
Third, whilst there may be temporary tidal waves of
it, portfolio investment is never going to bring enormous amounts of money,
simply because the amounts going every year to developing countries are so
small. If India wants really big foreign investment, it will have to be direct
investment.
The fourth follows from the third. If portfolio
investment is never going to amount to much in relation to our needs and the
size of our capital market, it makes no sense to maintain restrictions on it.
In particular, two restrictions are pointless. One is the ban on portfolio
investment by individuals. As I said, personal investors can evade this ban
even now, provided they are big and determined enough. As long as those
individuals submit themselves to registration with SEBI just like the FIIs at
present, there is no reason to exclude them. The second restriction is the
limit on total foreign portfolio investment in a company. It is based on making
a distinction between portfolio and direct investment, and on ensuring that
control of an Indian company does not pass into foreign hands without the
government being able to interfere (presumably on behalf of a reluctant Indian promoter).
But the 5 per cent limit on the holding of a single portfolio investment
already ensures that. If any limit on total foreign shareholding has to be set,
the company’s board can do it; it needs no help from the government. If foreign
portfolio investors own more than 50 per cent, and they may combine, they may
be able to replace the management. But so may a minority portfolio investor in
combination with domestic investors. Replacement of managements by shareholders
is a legitimate part of the rules of the game; a portfolio investor should not
be disqualified from it simply because he is a foreigner.
1997
|
1998
|
1999
|
2000
|
|
(to August)
|
||||
A. US new equity purchases ($b)
|
227.1
|
157
|
187.7
|
253.3
|
B. US new foreign equity fund investments ($b)
|
37.8
|
7.5
|
11.2
|
54
|
C. US emerging market equity fund investments ($b)
|
3.8
|
0.1
|
0.8
|
0.9
|
Ratio of B to A (%)
|
16.6
|
4.8
|
6.0
|
21.3
|
Ratio of C to B (%)
|
10.1
|
1.3
|
7.1
|
1.7
|
Ratio of C to A (%)
|
1.7
|
0.1
|
0.4
|
0.4
|
