|Loosen the bond|
|Tuesday, 17 September 2013 00:00|
FIIs haven't moved out of equity markets as much as from debt markets. There is a way to fix that.
Given how $12 billion has flowed out of Indian markets since May 22, when the US Fed first talked of tapering its monthly purchases of $85bn worth of bonds, it seems possible that a lot more could flow out when the actual taper begins. More than the actual announcement, smart money is betting on the entire bond purchase programme being over by the middle of next year, after which US interest rates could rise even more. If India doesn't increase interest rates by more than a commensurate amount, the logic goes, FII investments in debt will most certainly move out since the US economy is looking stronger while India's is looking weaker.
But that is a simplification. For, while FIIs have moved out $10.4bn from the debt markets since May 22, they have moved out just $1.6bn from the equity markets in the same period. Given that FIIs have invested around $145bn in India since 2000-01, this means just around 1 per cent of the total has moved out. While Indian policymakers should take heart from the fact that this means FIIs haven't lost faith in the India story, there is a more technical reason for this. And that has to do with the way FII fund managers operate. There is, at the end of the day, no real way to judge whether a fund manager has done well. Investors typically judge their fund managers on indices created by fund managers. One such is the Morgan Stanley Capital International (MSCI), which puts an ideal weight for each country on various parameters — so, if the MSCI Emerging Markets (MSCI-EM) has an India weight of 6 per cent, fund managers tend to put 6 per cent of their capital in Indian stocks. If they don't, and India stocks do well, the fund managers will be in trouble. If they put 6 per cent in India stocks and these tank, the fund manager is still okay since he is being judged by the MSCI-EM, which will also have fallen.
This is exactly what India needs to replicate in the debt, or bond market — become part of a global index fund. The JP Morgan Emerging Markets Index, for instance, is followed by $200bn of debt funds. What India needs to do is simply lift the ceiling on FII investments in government paper and it will get a 10 per cent weight in the index. The government fears the rupee will crash and yields will skyrocket if all bond holders exit at the same time. But that's exactly the lesson from the MSCI-EM, that long-term investors come into countries on such indices. Indeed, India will attract a lot more debt funds than it does now.