The FII Sellout

In the recent credit policy, though the RBI refrained from increasing the bank rates, it increased the Reverse repo rates. This clearly indicates that there is an upward pressure on the interest rates in India. US Fed has increased the interest rate for the twelfth consecutive time, which indicates that there is a revival in US economy and demand for credit is increasing. The current economic activity in US can absorb the higher interest rates. The high interest rates can put pressure on global investors to invest more in US.

FII investment is hot money in any developing economy as it comes in for short to medium term profits. It is not like Foreign Direct Investment (FDI), which has a long term commitment to a nation or an economy. The FII money is floating money, which is not country or economy specific but is return specific. It flows to that part of the world, which gives higher returns and better pay off as compared to the risk involved. The large outflow of FII money seen by the Indian stock market and other stock markets of developing nations in the last month is an outcome of profit booking activity of FIIs, which can affect the sentiment in any stock market.

India had good economic growth in the past few years. Not only its growth rate neared average of 7%, but the perception of the world about India, its potentials and its ability underwent a change. Though the high growth rate was achieved due to the reforms and also through the foreign investment in various sectors, keeping the momentum was not an easy job. To maintain high growth rate in Indian economy, it is essential to have high growth rate of agricultural production, which partly depends on the act of rain God. Further the manufacturing and service sectors will have to grow fast year on year. This can happen only with sustained reforms and foreign investment. For the last few years the economies of developed countries were sluggish. The obvious choice to the investors was developing countries like India and China. The money, which came in these countries, belonged to US, Europe and Japan. Now the scene has started changing. The US economy has started looking better. The third quarter of 2005 was one of the best quarters it had in the recent years. The unemployment has reduced. The rate of interest has hardened. Though the US stock markets have not moved up convincingly, there is definitely a better sentiment and better investment climate in US. The Japanese economy has started coming out of stagnation. The growth in Japan has resumed. The Europe may not lag behind much. The shock of high oil prices is absorbed by the world. The hot money has started moving back to the developed countries which are less risky and which have started offering high returns on investment.

This movement of funds is bound to affect the developing countries in Asia and also other part of the world. The effect on Asia is more pronounced, as it is one of the fastest growing regions of the world. The Asian stock markets are slowing down. The Chinese economy is cooling.

Though the India growth story is still on, we need to look at it with caution. Being on the top of the lot is not a function of how good you are but it depends on how good or bad the others are. Being the best is only relative term of comparison. Attractiveness of a destination for investment is not sustainable if other destinations become more attractive. India will need to remain attractive and competitive to sustain its growth. The main growth engine for India is service sector. The advantage comes out of comparative cheap work force and wide knowledge of English language. This advantage needs to be sustained. Other countries in Asia and even South America can start catching up. India can probably not match Chinese low cost. Still it can be a quality producer of goods. The quality of Indian products has started getting appreciation. It needs systematic efforts, good business ethics and practices. Industry should look at long term gains and not short term profits. Reforms are essential for high growth. Reforms are slowing down due to political pressures. This slowdown can slow the economy if external factor become non favourable.

The recent pullout of funds by FIIs has put pressure on Indian stock markets. With a withdrawal of less than a billion US dollars by FII, the stock markets have given away 10% of their value. The FII outflow due to external factors can create havoc in Indian stock market. Indian stocks are still not cheap. The rate of returns from stocks may not be very high in the near future unless an investor can time the market. In the next couple of months the stock markets are likely to be volatile and they may move in a price band.

The FIIs have been selling stocks in most of the emerging market and these markets have moved downwards across the globe in the month of October. I do not feel that the FIIs will aggressively buy in Indian stock markets at least till the New Year. If they continue pressing sales as they did in the month of October, it will be harmful for the stock markets. The investors with a short term horizon should not aggressively invest in the stocks as of now. Traders can trade with caution for 5% gains or losses. Markets will be volatile and the traders can get opportunity if they strictly play the game with the stop loss. If the stock markets come to level of BSE index of 7600, it may prove to be good investment opportunity with medium term prospects. Investors are advised to book profit if the index crosses the level of 8500 before December, 2005.

Lending and deposits are again emerging as good investments as the rate of interest is hardening and is likely to harden further. Investors can take exposure to fixed deposits of companies and government securities with short maturity. It is advisable to invest in debt-oriented schemes of mutual funds and even fixed maturity plans of terms between 1 and 2 years. These schemes, if held to maturity are likely to give post tax returns of about 6%. Liquid schemes of mutual funds are likely to give pre tax return of 5% in short run. Individual investors choosing dividend option can get post tax return of 4.5% and corporate entities may earn post tax return of 4%.

There are lots of factors on horizon, which may negatively affect the returns of equity schemes of mutual fund over a short term. The pull out of FIIs can affect the investment in an equity-oriented scheme unless it is held for a long term. I advise caution to the investors of equity funds with short term investment horizon. Indian economy being vibrant can still get good returns on equity oriented mutual fund scheme over a long period.

Gold has shoot up substantially in the recent months. It has hardened in spite of hardening of US dollar. The gold still remains in bull phase but investment at the current price may not yield attractive returns over a long period. The investors may get better opportunity of investing in gold during 2006.

It is advisable to stay away from fixed return investments with long term maturity such as NSC, Kisan Vikas Patra and even GOI relief bonds. The rate of returns on these investments may not increase unless there is substantial increased in the market rate of interest. Deposits with maturity period of one to three years are preferable for the time being.