India woos foreign capital to regain lost sheen

India’s top policymakers have made a new year’s resolution to avoid a repeat of what many local commentators describe as an annus horribilis for the world’s fastest growing economy after China.

Pranab Mukherjee, the finance minister, celebrated the new year by allowing foreign nationals, trusts and pension funds to invest directly in the country’s listed companies from mid-January.

His move is in the spirit of financial reforms 20 years ago that opened India’s capital markets to foreign institutional investment, and put Asia’s third-largest economy on the path to higher growth.

Widening the investor base has been received as a welcome emergency measure to help restore sheen lost last year from India’s economic transformation. But few analysts expect immediate results.

Kunal Kumar Kundu, senior economist at Roubini Global Economics in Delhi, sees the liberalisation as a response to a sharp pull-out by foreign portfolio investors that is putting strain on the currency.

“I am not sure it is going to reverse the trend any time soon,” he warns.

“At the end of the day, it is all about attractiveness of the market. Remember, even Indian investors are now more prone to investing outside of India than they are within India, given the various issues they are facing – policy paralysis and corruption.”

Waning investor sentiment triggered a 25 per cent drop in the Sensex, the benchmark index on the Bombay Stock Exchange, in 2011. The rupee, which had strengthened against the dollar, experienced a sharp sell-off, recording a 17 per cent fall against the US currency over the year.

After investing $29bn in 2010, foreign institutional investors pulled out $357m in 2011. Now leading economists, such as Shankar Acharya, an economist at the Indian Council for Research on International Economic Relations, predict difficult years ahead as India tries to recapture the euphoria of near double-digit economic growth.

The sense of crisis, highlighted by the weakening rupee and growing bearishness, has drawn a rapid response from the finance ministry and Reserve Bank of India, the central bank.

Other recent steps to boost inflows include encouraging more deposits by non-resident Indians with higher interest rates, relaxing accounting rules for foreign exchange loans and relaxing foreign limits on government bonds.

“Enhancing capital flows is likely to be a key theme in 2012,” says Rohini Malkani, economist at Citigroup, the US investment bank, in Mumbai. She expects more moves, some sector-specific, to relax restrictions on the capital account in the months ahead. The finance ministry says its latest move is intended to deepen the country’s under-developed capital markets. But a short-term goal is to stabilise the rupee.

Deepak Lalwani, director of Lalcap, an India-focused investment adviser, forecasts the rupee is in danger of slipping from current levels of Rs52 to the dollar to Rs60 in coming months.

Concerns are growing about India’s external sector management – the current account deficit and repayments of $137bn in external debt this year.

“India has been grappling with its external sector situation with a sense of urgency over the past three to four months,” says M.K Venu, managing editor of the Financial Express, a daily business newspaper.

Jim O’Neill, chairman of Goldman Sachs Asset Management, has warned about possible balance of payments difficulties surrounding a rising import bill and a weakening local currency.

Manmohan Singh, the prime minister, has aired his fears about a deteriorating fiscal deficit as state elections approach and battered confidence in economic reform after a humiliating reversal over opening up the retail sector to greater foreign investment.

Some analysts are hopeful of the longer-term benefits of greater access to Indian equities. “Once the market conditions improve, one can expect billions of dollars of investment into the Indian market through this route,” says D.K. Aggarwal, an analyst at Delhi-based SMC Investments. Others see it as a tardy repair job after a dismal year of political bickering, indecision and rising borrowing costs.

But, seen from outside, India’s growth, forecast at about 7.5 per cent this year, holds allure because of its economy’s sheltered nature.

Edward Bland, head of research at London-based Duncan Lawrie Private Bank, says India rather than China has his attention among fast growing economies. “The country to watch in 2012 is India,” he says. “I see India as a contrarian buying opportunity for investors.”

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