Indranil Sen Gupta, India economist
Bank of America-Merrill Lynch
We believe that the Reserve Bank of India (RBI) will have to focus on financing the current account deficit as, realistically, it cannot be compressed. India will likely see large current account deficits persist as long as we live in a world of low growth (which hurts exports) and high G3 liquidity (which pumps up the oil import bill).
We believe that the RBI will sooner or later need to take more pro-active steps to attract capital inflows. After all, the import cover – or the number of months of imports that foreign exchange (FX) reserves can pay for – has halved to seven months in the past four years. Unless the central bank adds to its FX reserves, it will find it increasingly difficult to maintain its present INR52-INR56 (US$0.96-US$1.03) per US dollar band.
We see three doable options. Firstly, the government has introduced foreign direct investment (FDI) in retail and proposes to introduce legislation to hike foreign direct investment (FDI) in insurance and introduce FDI in pensions. Finance minister P. Chidambaram has told the media that he wants FDI caps relaxed in other sectors as well.
Secondly, re-issuing 7%-9% five-year FX-denominated non-resident Indian bonds, with FX risk guaranteed by the government or the RBI, can raise over US$20 billion. Past issuances – like the 1998 Resurgent India Bonds or 2001 India Millennium Deposits – raised US$5 billion each and effectively arrested Indian rupee depreciation.
Thirdly, the RBI can raise foreign institutional investor (FII) debt limits and buy the FX leg to augment FX reserves. Another option is to issue sovereign debt. Foreign investors’ debt investment limits are being rationalised into two baskets: US$25 billion for gilts and US$51 billion for corporate bonds.
Interest in Indian gilts will likely persist as the RBI should be able to cut rates even if the Federal Reserve withdraws quantitative easing, given the 750 basis points (bp) rate differential between the two countries. Besides, the rupee typically appreciates when the US growth provokes the Fed into tightening as it is dominated by equity flows that essentially chase growth.
Rohini Malkani, India chief economist
Citi
With the current account deficit likely to touch record highs, India's focus on capital-raising through foreign inflows has increased, and will continue to do so in the following years. Of late policy makers have voiced concerns on the increased recourse to volatile flows to fund the current account deficit. In this context we could see a greater thrust to attracting stable flows.
On foreign direct investment (FDI), the reforms started in September 2012 when the government raised caps on FDI in important sectors like single-brand retail, aviation, and power exchanges. FDI in multi-brand retail was a much-contested issue, but was finally approved during the winter session of parliament earlier this year.
While opening up FDI in these sectors is positive, there remain many more sectors that could benefit from higher foreign investment caps. Moreover, sectors where caps have been raised would also benefit further liberalising. Thus, the finance minister has recently been emphasising the need to scrap FDI caps in many industries in order to improve foreign capital inflows. Industries where FDI caps could be removed or raised include real estate (where 0% is currently allowed), pension and insurance (26%), airlines, security, and power exchanges (49%), multi-brand retail (51%), banking and telecom (74%).
Going forward, all eyes are on implementation of pending reforms for FDI in pension and insurance, which would be positive moves to increase potential for FDI flows.
Similar to FDI, the foreign institutional investor (FII) segment, particularly the debt market, has also seen multiple measures introduced such as higher investment ceilings, permitting greater variety of financial instruments, and providing better hedging opportunities (through credit default swap). Recently more positive steps were taken when finance minister P. Chidambaram announced a simplification of norms for FIIs investing via the debt route.
Two key changes were proposed: Firstly, the removal of sub-limit restrictions for different categories. Effective April 1, there will only be two ceilings – a US$25 billion limit for investment in government securities and a US$51 billion sub-limit for corporate bonds. Secondly, investments are now “on tap” versus “auction mechanism”.
Other measures recently introduced to incentivise dollar inflows include: (1) Encouraging non-resident Indian deposits by de-regulating interest rates; (2) Relaxing ECB norms; and (3) Postponement of General Anti Avoidance Rule (GAAR) to 2016.
Going forward, measures to look out for could be: (1) higher FDI limits; (2) possible commercial bond issuance similar to the Resurgent India Bond (RIB); and (3) further incentives (tax) for the bond market.
Radhika Rao, economist
DBS Bank
Deterioration in the current account is one of the key macro challenges that India faces. Given the deficit and the desire to make growth more sustainable, there is a need to attract foreign inflows, with a preference for non-debt creating and stable foreign direct investment (FDI) over temperamental portfolio inflows.
The major thrust of September reforms was the relaxation of FDI limits, though subsequent efforts to raise the caps for the insurance and pension sectors encountered parliamentary roadblocks. The discussion on FDIs was revived recently, with the possible scrapping or relaxation of sectoral FDI caps in many industries. After the talk comes the need to follow-through and this is where the problems lie.
The external headwinds are beyond the authorities’ control. But India has also fallen for domestic reasons. A recovery here is possible, but it will be slow.
For one, the cost of borrowings could ease on the downward draft in benchmark rates. The others, however, require legislative and structural responses – in the infrastructure space, land acquisition troubles, need for clarity in legal/labour aspects, political hindrances and approval delays.
On a strategic level, the government could target global firms that wish to tap the domestic population, alongside exports-oriented manufacturing firms. The latter will inherently improve the economy’s productive capacity and support the external sector as well, as has been the case in Philippines and Thailand, for instance. These, however, only got more difficult after the re-emergence of political risks and worries over policy continuity post-general elections.
There is limited scope for a turnaround in the short-term, with a cyclical upturn in growth likely to come first, lifted by consumption and government spending. This might translate into higher capital expenditure spending and improvement in capacity utilisation by domestic companies.
Foreign investors would be expected to follow thereafter, when the upturn is on a firmer footing. For now, reliance on portfolio inflows is set to grow, with much of the official focus on ensuring stability in the financial markets and political continuity.
Sanjiv Duggal, investment director, equities
HSBC Global Asset Management
The government more so than before realises the importance of attracting and retaining foreign capital flows. This was evidenced by an upfront mention in the finance minister’s recent budget speech of the need to attract foreign direct investment (FDI), foreign institutional investors and foreign debt inflows. The culprit-in-chief has been the rise in the current account deficit fuelled by oil imports and blinded by gold imports.
India has to go on a charm offensive to showcase the incredible opportunities for foreign longer-term capital. The country should encourage, facilitate and smooth the path for foreign capital. The level of red-tape and the numerous approvals required need to be streamlined along with much shorter time lines. An encouraging sign is the competition amongst some states to attract capital, be it foreign or domestic. India has all the other ingredients to make this a tasty investment recipe – plenty of labour, raw materials and consumers – we just need the salt/sugar, which is capital.
According to the Organisation for Economic Cooperation and Development (OECD), India ranks among the fourth most restrictive country for FDI. The ranking is based on four parameters: foreign equity limitations; approval mechanisms; restriction on employment of foreigners; and operational restrictions. The ratio between actual FDI and approved FDI is only around 60% and that implies various approved FDI do not translate into actual FDI due to operational issues. An easy solution is to focus on the 40% that got away – getting this money back in would raise FDI by two-thirds.
India is one of the most attractive destinations for global companies to sell their products and also manufacture them to be sold elsewhere and the only way this potential can be fully exploited is by providing stability in policies and making it easier for FDI to find a long-term home in India.