Foreign investors appear to have rediscovered India. The inflow of foreign capital into India’s stock market in the month of March hit a high of $4.89 billion, the biggest foreign inflow into Indian stocks since February 2012. As a result, the stock market rose a solid 8% in March. Foreign investment in Indian equities stood at $2.42 billion in February, as against a net outflow of $4.4 billion during the same month a year earlier, and is expected to be strong in April as well. Both cyclical and structural factors are behind this sudden uptick in foreign investment that has helped the rupee make an impressive comeback. The rupee has appreciated by about 7% since early October, when it was reeling at around 74 against the dollar. Last year, India received more foreign direct investment than China for the first time in two decades. While the Chinese economy has been slowing down considerably in the last one year, India has emerged as the fastest-growing major economy. Doubts over the robustness of the GDP calculation method notwithstanding, it is clear that investors expect India to be a major source of global growth in the coming years. Other short-term reasons may also be behind some of the recent inflow of capital into the country. For one, there is a sense among a section of investors that their fears of political instability are misplaced. More important, there are clear signs that western central banks have turned dovish. Both the Federal Reserve and the European Central Bank, for instance, have promised to keep interest rates low for longer. This has caused investors to turn towards relatively high-yielding emerging market debt. Indian mid-cap stocks, which suffered a deep rout last year, are now too attractive to ignore for many foreign investors.
The return of foreign capital is obviously a good sign for the Indian economy. But policymakers need to be careful not to take foreign investors for granted. Other emerging Asian economies will be competing hard to attract foreign capital, which is extremely nimble. Any mistake by policymakers will affect India’s image as an investment destination. To retain investor confidence, whichever government comes to power after the general election this summer will need to increase the pace of structural reforms and also ensure proper macroeconomic management with the help of the Reserve Bank of India. Long-pending reforms to the labour and land markets are the most pressing structural changes that will affect India’s long-term growth trajectory. The high fiscal deficit of both the Centre and the State governments and the disruptive outflow of foreign capital are the other macroeconomic challenges. These are some issues that need to be solved sooner rather than later.