FDIs now pouring into India

After six months of financial drought, global money is flooding into India at the rate of $ 1 billion a week. If sustained, this will be the mother of all financial stimuli, eclipsing the finance minister’s budgetary endeavors.

The dollar flood is not due to the Congress election victory. In April, foreign institution investors (FIIs) poured $1.3 billion into Indian equities. For May as a whole, the inflow was $4.14 billion or a billion a week.

This is part of a global phenomenon. Since April, $ 20 billion has flooded into all emerging markets. The Sensex is up 50% in 2009. But Russia is also up 63%, China 57%, Brazil 60%, and Argentina 45%. So the dollar flood is not India-specific: it is part of a global rush into all emerging markets, especially the BRIC’s (Brazil, Russia, India, and China).

Till March global markets were paralyzed by fear. The global meltdown had brought down some of the world’s biggest corporates – the top five investment banks, the biggest insurance company (AIG), the biggest bank (Citibank) and the biggest auto company (General Motors). Global investors fled into US gilts carrying almost zero interest, fearing that anything else was unsafe. FIIs pulled $12billion out of India in 2008, and the biggest Indian corporates couldn’t get global funding. Their profits and projects were hard hit.

But the darkest hour is before dawn. After hitting rock bottom in March 2009, global investors finally sensed that governments across the world had, by pouring trillions into rescues, ensured that the crisis would not get worse. The pall of fear lifted. And investors started moving out of US gilts earning virtually no interest into investments with higher returns.

Now, economic conditions in the US, Europe and Japan remain grim. Despite rescues, their financial sectors remain stressed, as rising defaults in credit cards, realty and corporate loans add to the travails from the earlier housing bust. The IMF estimates negative to zero growth in these large economies till late 2010. But emerging markets, especially the four BRIC’s are registering positive growth. India’s quarterly GDP growth of 5.8% may look very weak compared to its earlier peak of 9%, but is nevertheless fabulous compared with zero or negative rates in the advanced economies. China has decelerated from 12% to 8% but that remains the highest in the world.

So, with fear lifting, global billions are moving out of safe havens into growth havens. Risk premiums on all financial assets were sky-high in March but have now fallen sharply. Global billions are moving into junk bonds, corporate debt, commodities and emerging markets too. Idle money waiting to be invested adds up to least $2 trillion, may be much more. If just $100 billion of this goes into emerging markets, that will fuel stock market booms.

Skeptics say this is another bubble in the making, unjustified by current profits or any change in India’s economic fundamentals. Now, foreign direct investment in factories is certainly better than FIIs inflows into stock markets. But the flood of $1 billion per week is not just speculative froth it is actually improving our economic fundamentals.

Earlier the economy was hit by a negative feedback loop. That is, stress in banks reduced credit to industries, which then suffered falling profits and loan defaults. These in turn worsened the balance sheets of banks, which then lent even less to industry, in a vicious downward spiral.

The new flood of $ 1 billion a week is changing the negative feedback lop into a positive one. Suddenly real estate companies that were almost insolvent and could not attract either loans or equity have been able to place almost $ 2 billion with qualified institutional investors.

If shady real estate companies can attract money, anybody can. Suddenly access to finance has become easier and cheaper: Improved finance means improved profits in industries which mean fewer loan defaults. This in turn betters balance sheets for banks, which will be able to lend more to industries, in a virtuous upward cycle.

Thus, a positive feedback loop is replacing the negative one. The bad news is that exporters will be hit by the appreciation of the rupee caused by the dollar flood. The positive feedback should lift India’s GDP growth to 6-7% in 2009-10, up from earlier estimates of 5.6%. That is a substantial gain, though revolutionary.