Foreign investors are losing confidence in India’s short-term growth prospects

Global oil prices are rising, the Indian rupee is depreciating, the government’s current account deficit is increasing. Government bonds are becoming riskier investments, and now, foreign portfolio investors are exiting India in droves, culminating in the largest monthly outflow since demonetisation was announced.

From May 1st to May 25th, foreign investors pulled out a total of ₹267.7bn from Indian bonds and stock-markets, according to depository data. As a result, the total outflow is on track to exceed the ₹271.1 billion that they pulled out in December 2016 - the month after the government imposed its demonetisation initiative. This will be the highest outflow of foreign money in 18 months.

Consistent outflow

The investor panic after demonetisation was short-lived, as foreign investment stabilised and gradually increased in 2017-18. This was largely due to the implementation of the insolvency and bankruptcy code, the new GST law, surging stock-markets, a rebound in manufacturing growth and depressed interest rates in developed countries like the US.

However, the outflow of foreign investment has been consistent in 2018 so far, pointing at a deeper malaise and lack of confidence in India’s short-term growth trajectory. In April, foreign investment outflows totalled ₹155bn, a 16-month high. In addition, March yielded a meagre net inflow result of ₹26.5bn, only due to equity inflows, while net outflows in February 2018 totalled ₹116.7bn. In fact, as of May 25th, foreign outflows from India have totalled ₹291 billion in the year so far.

Rupee set to weaken further

As foreign investment continues its downward spiral and oil prices increase, the rupee will only weaken further as there are less foreign investors entering the economy and buying rupees. The Reserve Bank of India is trying to do its best to stem the fall, by using up its dollar reserves to prop the currency, but as its foreign reserves dwindle, its ability to intervene in the future will be compromised.

This scenario isn’t only limited to India, though. After years of low interest rates in the US and across Europe, money came from these countries into emerging markets in Asia and South America in search of higher returns. However, as interest rates in these developed markets are on the upswing, less money is leaving them.

Paul Krugman, a Nobel Prize winning economist, raised alarm bells last week, when he pointed to an impending crisis in emerging markets, based on the drastic decline in currencies, the pileup in dollar debt and slowdown in economic growth.

For now, foreign investment in India is tied to the country’s growth rate over the next few quarters, which is in turn, tied to oil prices. If India exceeds quarterly growth estimates, it will be able to lure investors back. However, with oil prices set to hover around $80 a barrel a near term, maintaining growth, let alone exceeding predictions, will be extremely difficult.

It seems that foreign investors will continue to pull money out in the near term. As a result, the Indian government will have no choice but to rely on demand and investment from domestic entities to keep the bond and stock markets afloat.