Inflation and falling rupee keeping away FII flows

The need for good returns and the very low single digit growth rate in the West will drive more foreign flows into Indian markets. But the short-term outlook for FII flows looks unstable in India given high interest rates, stubborn inflation and a depreciating rupee. That is what Ranu Dayal, partner & director, Boston Consulting Group, New York, feels.

Dayal is leading BCG’s project in collaboration with the World Economic Forum (WEF) on Emerging Market Financial Services. He spoke to Firstpost on the sidelines of the Indian Economic Summit organised by WEF in Mumbai. Edited excerpts:

[caption id=“attachment_132320” align=“alignleft” width=“380” caption=“People only expect US to get 3-4 percent return and so they see emerging markets as the only destination to get good returns.Reuters”]  [/caption]

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When you look at investor sentiment of foreign investors in the context of India, what are the changes you see?

A: The first thing I notice is that people’s expectations of rate of return has declined. People only expect US to get 3-4 percent return and so they see emerging markets as the only destination to get good returns. And India stands out even among the emerging market nations where expected growth rate will be significantly higher than other nations.

Do you endorse the view that India is expensive in valuations when compared to its emerging market peers? Does it deserve the premium?

A: I do not think India is getting any undue premium by any means. Its valuations are not out of line by any means and many think that Indian valuations are also sustainable. But there are two significant issues here: rupee is seeing its historical lows, and inflation is very high and sticky now. So an external investor has to factor in these two issues. That is creating instability in investor’s decisions.

There is also a view that it is not valuations or fundamentals but FII money flow into our market that drives returns. So, is the Indian market stable enough to attract FII flows now?

A: There are two very different drivers that are now instigating investors. One is the need for yield or return on one hand, and the other, as we discussed, the structural issues like high interest rates, inflation and a falling rupee. The former will ensure that in the long term, investors will invest in India to get good returns. But the latter issues will pose timing issues in the short term for investing here.

[caption id=“attachment_132307” align=“alignright” width=“200” caption=“Ranu Dayal,partner & director, Boston Consulting Group, New York.”]  [/caption]

Talking of policies, what are the changes you would like to see immediately to help investing sentiment in India?

A: Easing of policy rates and tackling inflation will help the equity markets. But I am more concerned with the debt market. There can be policy changes to encourage a more vibrant bond market as I believe bonds will have a greater role to play as means of financing. That can be further used for infrastructure financing or in other areas as well.