Leak In The Coffers

It completed its silver jubilee in style and was on its way to a golden one. Starting October 2003, in a 34-week dream-run—except for one week in January 2004 when it dipped marginally—India's foreign exchange reserves only moved northwards. In fact, the reserves increased by an unbelievable $1-1.5 billion in most weeks. But since the swearing-in of the UPA government on May 22, the reserves have stagnated and, in some weeks, come down. "The sustained forex reserve growth is not happening anymore," says a finance ministry official. So, what has changed in the last three months? And does this mean that foreign investors have lost faith in the India story that was so attractive just recently?

The initial setback came in the form of depressed sentiments. A major reason was the Congress would have to muster support from the anti-reforms Left parties. This forced some investors, most notably the NRIs, to stay away from India. Even as the Left parties started making the right (sorry, wrong for foreigner investors) noises against disinvestment, the stockmarket plunged. On Black Monday (May 16), the Sensex witnessed a whopping 842-point fall—the highest in its history. Now, it was the turn of the foreign institutional investors (FIIs) to shy away.

While the markets recovered (today, the Sensex is again above 5,000 points), and two known reformers—Manmohan Singh and P. Chidambaram—took over key portfolios, the forex situation became worse. The Federal Reserve has hiked the interest rates in the US, not once but twice. LIBOR, or London inter-bank rate, too, has gone up by 75 basis points (or 0.75 per cent) in the past few months. In addition, the rupee, which was appreciating against the dollar for quite a while, starting going down. And it continued its slide against other currencies like the pound and the euro. Of course, the RBI has been responsible, to some extent, for the rupee's downward curve against the dollar, as it has recently intervened in the currency market.

As sources in RBI explain, the combination impacts capital flows in a negative manner. Higher global interest rates and depreciating rupee makes investments in developed nations more attractive for both FIIs and NRIs. "The growth in NRI inflows has been hit substantially in recent weeks," says a government official. Even the RBI agrees, although it has not finalised the latest figures for the components that constitute forex reserves.

FII inflows over the past few weeks hint that they are willing to "wait and watch", rather than increase their exposure in India. Between April and June 2004, the FIIs injected over $1 billion in Indian stocks. But after being net buyers ($62 million) in the first week of July, they turned net sellers in the second week ($17 million), and became buyers ($54 million) again the following week. In July, the net inflows/outflows were meagre and, hence, there was not enough money coming in to push up the reserves. But the FIIs were active in other Asian markets; between July 12 and July 22, they invested $650 million in the South Korean market and took out over $350 million from Taiwan.

Higher inflation (now 7.61 per cent), rising oil prices ($47 a barrel), fears of lower agriculture growth, and the subsequent scaling down of GDP growth estimates haven't helped. These negative indicators have fuelled questions about the macro-economic health of the Indian economy. And it only intensifies the desire among risk-averse foreign investors to seek alternative destinations.