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India has tallied $12.5bn in foreign inflows so far this year, according to the Securities and Exchanges Board of India – more, at this point in the year, than any year but one of the last ten. That’s a rare bright spot.
But it raises a couple of important questions, addressed in recent analyst notes: when the economic picture is so bleak, why is that money pouring in? And who is doing the pouring?
The answer may just be that oldest of Indian pastimes: black money.
First, the context: data released on Monday showed that Indian industry grew just 0.1 per cent in July, and shrank 0.1 per cent since the beginning of the fiscal year in April. That weak figure is on top of the 5.5 per cent the economy grew in the June quarter, and the near 7 per cent inflation it continues to experience.
As Nick Paulson-Ellis, India country head for Espirito Santo, put it in a note to investors on Tuesday:
A seemingly endless political comedy show in Delhi, precipitous falls in consensus GDP forecasts, stubborn inflation, off track fiscal consolidation, threat of sovereign downgrade, building problems of asset quality in the banking system and now early signs that even consumption growth is beginning to roll over – not exactly a list of reasons for foreign investors to increase allocations to India.
BNP Paribas’ Manishi Raychaudhuri and Gautam Mehta raised similar points, and wrote:
In this context, the magnitude of FII inflows into India is indeed befuddling. Put differently, what are AxJ and GEM funds seeing in India – given that they have increased exposure to India both in absolute terms and in relative terms – that we don’t.
BNP goes on to note that one reason may simply be that those in-country “tend to have a blinkered view of the situation. So, while things may be bad in India, other EM peers are no better… while earnings forecast have declined across the region over the past few quarters, the worst of the earnings pressure seems to be behind India”.
But Espirito Santo isn’t biting, given the scale of the flows:
Sure one can make counter arguments around the earnings cycle potentially having bottomed, India being an excessive underweight in December 2011, or the PMO’s focus on project clearances potentially kick-starting the investment cycle, but one is still left wondering if this really explains the apparent strength of flows. So what is going on?
Paulson-Ellis knocks down the argument that the flows emanate from ETFs by looking at fund flow data from EPFR, a data service that tracks $15tn of global funds. As of Tuesday, it showed year-to-date inflows of just $1.1bn, mostly ETFs. “It is important to stress that EPFR and SEBI data is quite different, and hence should never match, but the magnitude of the gap this year is striking,” he wrote.
While EPFR tracks mutual funds and ETFs, Sebi tracks all cross border flows into equities, including mutual funds, hedge funds, prop desks, private company investments and high net worth individuals.
That last one therein, perhaps, lies the rub.
Paulson-Ellis wrote that the inflows “frankly includes round tripping of money through Mauritius and return of black money through the FII route in response to perceptions about rupee value”.
Raychaudhuri and Mehta noted that a large component of the inflows remain unexplained. “Such a large quantum of money coming from ‘non-regular’ sources lends credence to the oft-repeated conspiracy theory that a lot of FII flows into India are, in reality, Indian money disguised as FII money,” they wrote.
The round-tripping through Mauritius is precisely the route that the government had targeted with their controversial General Anti-Tax Avoidance Rules, which had sent investors fleeing and forced the government to consider a deferment until 2016.
If that is the case, and inflows remain unchecked, perhaps we can expect even more money pouring into India in the next few years.