Will Capital Flows to India Increase in 2012?

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This year, Morgan Stanley’s global analyst team, which covers 1,766 companies, reckons that 339 of these companies have plans to invest in India. These investment plans add up to a pipeline of about $80 billion over the next 12-24 months. Their primary reason to invest is India’s large and growing domestic market [and not] to build a global scale manufacturing.

Historically, these companies have been European, but now American and Japanese companies are gaining share. In terms of sectors, metals, mining, technology hardware and auto are on the upswing. It shows there is a great interest for FDI [foreign direct investment] in India.

This evidence is backed by the lobbying disclosure filings made by US companies over the past few quarters — i.e., the amount of money they spend with their lawmakers on matters concerning their business — as well the recent FDI that has come into the country.

This year, India has been among the worst performing equity markets. But it has not been subject to too much net outflows in the equity markets — that certainly calls for more research. I think there are people who draw the numbers from Emerging Portfolio Fund Research [EPFR] and compare it with FII [foreign institutional investors] flows and then say that the two don’t match and worry about the source of flows to India.

But you have to remember that EPFR does not cover all funds that invest or can invest in India. In the past few years, flows into India have diversified and India is receiving money from many more sources and not just emerging markets.

My view from people I’ve spoken to is that this year, traditional investors, India-dedicated funds, hedge funds and emerging market funds have sold equities worth $10-12 billion and this may be the net purchases by US pension funds. This could be an interesting thing in 2012, as traditional fund managers appear under-exposed to India at this stage.

There’s a fair bit of fatigue about India and pension funds are waiting for the market to fall, to put money to work. So, I feel that even FII flows would be okay next year. The caveat is that we should get a 2008 kind of event because if the European situation doesn’t get resolved, it can lead to a capital market freeze that causes an outflow of money from India. With its current account deficit, India can face some stress in terms of growth in such a scenario.

Out of all the emerging markets, generally, investors acknowledge that India is the most promising. Two advantages that India has are that it has got a fully functional democratic setup, and secondly, we’ve got a ready consuming class that comes from a sense of security, so we don’t have to push people to consume. If we can get the investment story right, India will be the hottest place on the planet.

Ridham Desai is the MD heading the India Equity Research team (ranked No. 1 in Asia in 2010) and strategist for Morgan Stanley.

(As told to Bharat Bhagnani)