Resilient growth outlook seen bringing FPI flows back to India

A likely tapering of rate hikes by US Fed is also seen taking the global sheen off the dollar and working in favour of emerging markets

Following a year of heavy capital outflows, Indian financial markets are likely to be recipients of overseas portfolio investment in 2023 as domestic economic growth, while seen slowing, is still likely to outpace that in several pockets of the world, analysts said.

With the global economy likely to take a large knock in 2023, India’s relatively stronger growth footing, coupled with low existing levels of foreign investment into emerging markets puts the country in an advantageous position. A likely tapering of rate hikes by the US Fed is also seen taking the global sheen off the dollar and working in favour of emerging markets.

“What has been very interesting is that in spite of the massive ramp-up in central bank balance sheets in the developed world in response to the pandemic, we haven’t seen that money allocated to emerging markets the way it was in the past,” Sameer Goel, Managing Director and Head of Emerging Markets & APAC Research, Deutsche Bank said to Business Standard.

“I think India even with a growth slowdown will be the fastest growing major economy and therefore there will be a certain amount of appeal for its assets. With China’s re-opening, it certainly feels like the emerging markets outlook has a more positive risk-reward compared with others,” he said.

According to the International Monetary Fund’s latest world economic outlook, global growth is forecast to slow to 2.7 per cent in 2023 from 3.2 per cent in 2022. The RBI in December said that it expects India’s economy to grow at 6.8 per cent in the current financial year. The central bank projects the domestic economic growth at 6.5 per cent in the next financial year, which would still make it one of the fastest growing major economies.

“That’s very positive as far as the appetite for Indian assets is concerned. Then of course there is a large structurally positive story, whether it’s demographics or manufacturing FDI, greater regulatory improvements, digital transformations etc,” Goel said.

“This should attract a much larger global capital inflow into the country which I think builds up a relatively positive story. The rupee is also a very high-yielding carry currency which attracts from a portfolio investment standpoint,” he said.

In 2022, foreign portfolio investors were net sellers of Indian stocks and debt to the extent of $16.5 billion and $2 billion, respectively, NSDL data showed.  The outflow of portfolio investment in the previous calendar year is the largest on record and far outstrips the $9.3 billion net outflow from stocks and bonds that occurred in 2008, the year of the global financial crisis.

The principal factors behind foreign investors’ decision to exit Indian markets in 2022 were the surge in global commodity prices caused by the Ukraine war and the US Federal Reserve’s most aggressive monetary tightening cycle in around two decades.

The risk aversion caused by the war in Europe and the higher US interest rates both sent global investors rushing to the American currency, which notched up around 8 per cent in 2022.

According to a recent note by DBS Bank’s economists, from the perspective of investment flows, India would stand to be a major beneficiary of the ‘China plus one’ strategy for global manufacturing.

The foreign bank pointed out that financial markets were buoyant, credit and consumption demand were still firm and that purchasing managers’ surveys showed confidence in the near-term outlook despite growth in exports taking a hit.

While voicing concerns over sputtering external demand, weak global market sentiment and regional trade dynamics, DBS Bank’s economists said that the odds were stacked in favour of positive surprises for India and China.

“Beyond the energy inflation shock of last year or ongoing liquidity tightening worldwide, India’s economy is affected by external demand, sentiment of global investors, and regional trade dynamics,” they wrote.

“These are not flashing bright green right now. We don’t think the soft patch in the making will last long, and like China, find the outlook characterised by upside risks, especially given the easing of energy prices,” they wrote.

In a 2023 outlook note Bank of America Securities said that an analysis of three recessionary cycles in the US indicates that India’s overall economic growth suffers to a lower extent, even as export growth takes a large knock.

Given that the appeal of emerging market assets is primarily driven by growth prospects, diminishing returns from markets in advanced economies is seen propelling some degree of FPI flows into equities after the large-scale outflows in 2022.

“India's GDP growth contracts less at -190bps on average vs -280bps for the US... Indian markets deliver much higher returns vs the US, 12-months post the recession,” BoFA Securities wrote.