Navigating The High Tide

Context: Prospects of India’s turnaround in foreign portfolio (FPI) inflows in FY21.

India’s turnaround in FPI inflows: FPI inflows reached $36.8 billion in 2021, only second to $42.2 billion in 2015.

Factors that drove FPI inflows

• Push factors: High global liquidity with major central banks pumping in $10 trillion since the crisis started.
• Pull factors: Cyclical pull factors such as domestic growth, fiscal and current account stance, and India’s swift economic rebound after the first wave of Covid-19.
• GoI’s tactical reform push: Which included reforms on agriculture, labour, production linked incentive (PLI) scheme and cut in corporate taxes.
• Monetary policy credibility: Emanating from a flexible inflation-targeting framework helped as RBI embarked on relentless policy support for growth during pandemic.

Significance of FPI inflows

• Higher aggregate investment, output and consumption in terms of real economic outcomes, as cited by a recent Bank for International Settlement (BIS) study.
• Improve financial stability: As financial institutions can access more diverse sources of funding, financial conditions become less responsive to negative domestic shocks. This has been evident in India lately.
• Helped offset outflows on account of other forms of capital: Critical role in the build-up of forex reserves.
  • 37.5% of the increase in forex reserves of $98.3 billion during the year was accounted for by FPI inflows.
  • This led to remarkable stability in the rupee, appreciating against US dollar in 2021.
• Reduce risk through imported inflation: And resulted in a supply of liquidity in the economy, thereby aiding the conduct of monetary policy.
• Fuelled sharp rebound in equity markets: Retail investor folios in mutual funds surged by 7.5 million, while assets under management (AUMs) of the retail segment increased by Rs 2.8 trillion during FY2021.
  • Lowers consumption volatility: The wealth effect and financial savings for the middle class can support consumption demand aiding the country’s economic recovery once pandemic subsides.

Potential risk factors

• Risk of volatility aided by US fed policy, global shocks etc.
• Commodity price fluctuations and shifts in global investors’ risk appetite.
• Risk of any setbacks to India’s cyclical pull factor and growth prospects due to third Covid-19 wave or deterioration in ‘quality of growth.

Conclusion: Avoiding long-term scarring, preventing a collapse in consumption engine, and widening urban-rural chasm will be more effective as compared to $600 billion-plus forex reserves and a rich monetary policy toolkit when the next shock hits.