Foreign portfolio investments in Indian equities has become such an essential ingredient of the Indian bourses that it has become necessary to study, interpret and forecast the FII behaviour.

This need has become all the more acute right now, as the Bombay Stock Exchange's sensitive index, Sensex, has apparently hit a bottom at 3720, and there are no signs of recovery as yet.

One serious concern that engages the mind of all investors, both domestic as well as foreign, is the steep depreciation in the rupee. Such a depreciation could put out the enthusiasm of the FIIs for Indian stocks. Ultimately FII investments or disinvestments decide which way the Sensex is headed.

What could be the reason for the new hesitancy for the FIIs to invest in India? But before one gets into that exercise, one is well aware by now, that lack of FII investments could well have other reasons, like the need to make redemptions. There are also other irrational reasons. These are the suspected knee-jerk reactions, whenever turmoil hits currency markets. There is a generalised fear about investments in the Asian region from overseas investors that could bind the arms of the fund managers to not invest more even in India. On the other hand forced with redemptions, it would not be surprising if fund managers decide to take profits on their Indian stocks. This would also make sense for as the liquidation in other Asian stocks proceeds, the share of the Indian stocks in the portfolio is bound to go up. This would violate all fund management rules. So instead of actually holding and buying more Indian stocks, FIIs may actually trim down their Indian holdings! First, let us take the market perception on the Indian rupee. In the very recent past, the Reserve Bank of India had to intervene to stem the rupee's slide. Last week the spot USD/INR, opened at Rs 36.33/34 and dipped to Rs 36.58/59 by November 7. The sentiment on the INR appears to have undergone a change. The perception of risk for the depreciation of the INR appears to have turned acute with the withdrawal of the GAIL GDR issue. And with FIIs pulling down the MTNL scrip in the bourses, the uncertainty regarding the rupee exchange rate has further increased.

For the two issues were expected to bring in $2 billion in the last two months of the year. That money would have served to bridge the fiscal deficit. But if one were to make a tighter assessment of the exchange risk, one needs to go into the other aspects of the Indian economy as well.

The current account deficit estimated to be in the region of 1.5 per cent of the GDP for the current fiscal. The other sensitive factor that could put pressure on the rupee is the quantum and quality of external debt. The ratio of total external debt to GDP in India is currently at around 27 per cent. The permission to resort to ECB funds has been carefully calibrated over the last two years. It is only in the area of portfolio investments that the country has had a more liberal approach raising the limit for FII holdings in companies.

Again a nation's currency could be under pressure, when loan repayments get heavy and bunched together. As far as India goes, short-term external liability of less than one year at March, 1997 was only $6 billion, just seven per cent of the total external debt of $90 billion. This in itself has an in-built factor for insulation against a speculative attack on the currency at any time, even when short term circumstances turn disadvantageous to the country. Inflation, fiscal deficit and interest rates are the other criteria, which impact decisively on the exchange rate. The inflation, however, is well controlled and does not add to the currency risk. Talking of interest rates, the RBI's latest measures in monetary policy would ensure that the interest rates would continue to be at low levels for at least another six months.

The vulnerability of the INR can perhaps be co-related closely to a single factor, fiscal deficit. The fiscal gap has been increased by the Fifth Pay Commission recommendations, and is expected to be bridged by the additional revenue efforts. But one cannot rule out the uncertainties associated with the inflow of revenue. The other measure to plug the fiscal gap is the downloading PSU shares.

It is here that the government has run into rough weather. So all said and done, there is some vulnerability to the rupee, but not extraordinarily high. Compare this degree of vulnerability with the potentials of the stock markets itself. Over the last 12 months, the Sensex went up from around 2800 to 4600, a gain of around 60 per cent. That kind of gain provides ample cover for the currency risk. Right now, US investors are reported to be pouring millions of dollars to be invested in US stocks rather than those abroad. But soon the opportunity of investing in a market which has reacted would be over. Thereafter, there is hope that these funds would again explore other avenues.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.