Capital inflows to remain muted in Q2, can’t bridge CAD: CMIE

The gloom over capital inflows into India is likely to extend from the June quarter into the September quarter, albeit at a lower intensity. An exodus of foreign investors, external borrowing becoming costlier and a sharp drop in NRI deposits impeded foreign capital inflows into the country during the first quarter of the current fiscal. The hindrances are expected to moderate in the current quarter, taking some sting off the outflows.

The improvement, however, is likely to be inadequate to bridge the estimated current account deficit, despite expected improvement in the macroeconomic indicator, says a recent report by Centre for Monitoring Indian Economy (CMIE).

Foreign portfolio investments were the worst hit among the major components of capital inflows in the June quarter, the think tank avers. NRI deposits also saw decline during the period, and the results of the measures recently taken by the Reserve Bank of India to rejuvenate them are awaited.

Meanwhile, foreign direct investments (FDI) bucked the trend to reach satisfactory levels in the first quarter, with signs they will remain buoyant in coming months as compared to other sources of capital flows. While external commercial borrowings registered some inflows, they are likely to remain muted in both the first and second quarters of FY23, with the U.S. Federal Reserve moving ahead with its rate hike cycle to rein in inflation, CMIE states.

“Foreign institutional investors (FIIs) exited Indian equity and debt markets by divesting a massive $14.4 billion during April-June 2022. They had drawn out an even larger $15.5 billion from these markets during January-March 2022. This looked like a relentless departure of overseas investors,” the CMIE report says.

The FIIs’ exit has been motivated by the U.S. Fed rate hikes, leading to huge capital outflows from the Indian financial markets. With the June U.S. inflation reading at a four-decade-high of 9.1% and the latest Fed rate hike of 75 basis points, Indian markets are expecting these outflows to continue. However, the recessionary fears with steep rate hikes has softened commodity prices, and this may somewhat restrict FII outflows from India, CMIE says.

“During the first three weeks of July, FIIs invested, on a net basis, $200 million into the Indian capital market. So, July 2022 is likely to record net FII inflows,” it adds.

NRI deposits flowing into India have also tapered off, restricting a major capital inflow route for the country. As per the CMIE report, net NRI deposit inflows stood at $0.42 billion during April-May 2022, at a monthly average of $0.21 billion. These were lower than the average monthly inflows of $0.27 billion recorded during 2021-22; the past fiscal had also seen NRI deposits dry. Average monthly inflows through this route were $0.6-0.9 billion in each of the preceding three financial years.

“After the recent easing of restrictions by the RBI on FCNR(B) and NRE deposits, various banks hiked interest rates on these deposits. As a result, NRI deposits might record inflows in the coming months, although news reports suggest that the hike in interest rates do not adequately offset the returns on yields overseas and the risks of the rupee depreciating,” CMIE observes.

The rising Fed rates and falling rupee have also turned external borrowings costlier, which will possibly hold back Indian enterprises from opting for this route of capital inflows. External commercial borrowings (ECBs) have remained sluggish so far in FY 2022-23, with only $1.7 billion raised through this route during April-May 2022. While Inflows recovered to $1.4 billion in May from $0.33 billion in April, this is only a fraction of the average monthly foreign borrowing of over $3 billion recorded during each of the preceding four years.

“Uncertainties have raised the cost of hedging exchange rate risks. In comparison, domestic borrowing rates such as the marginal cost of funds based lending rates (MCLR) have not increased much. Inflows under ECBs will remain low in the quarter ended June 2022. They are also likely to remain low in the quarter ended September, as well,” the agency says.

Meanwhile, foreign direct investment (FDI) presents a contrasting picture in the first two months of FY23, with net FDI to India at $11.4 billion. Gross inflows were at $16.4 billion against repatriation/disinvestment of $5 billion.

“The trend in FDI to India, so far, indicates that FDI flows are likely to remain buoyant in the coming months when compared to other sources of capital flows,” CMIE says.

CMIE expects drawdown in forex reserves to continue in the September quarter even with the possibility of lower capital outflows and some improvement in current account deficit, but it is likely to be lower than that seen in the June quarter.