India may be seriously struggling under the weight of COVID-19, but its domestic capital markets continue to be an attractive investment destination for foreign institutions. Supported by its recent positive market reforms, experts are confident that India will make a robust recovery moving forward.
Navigating through a crisis
COVID-19 has devastated India although there are early indications that infections are starting to decline. Despite this gradual levelling-off, Anubhuti Sahay, Head of South Asia Economic Research at Standard Chartered Bank, stressed COVID-19 cases were still incredibly high in the country, hovering at three times the peak witnessed in September 2020. While India is projected to see its GDP (gross domestic product) growth contract by roughly 7.3% in 2021, Sahay anticipated there will be a 10.2% rebound in 2022. “The economic recovery from the first wave was much better than what many people expected. Even though the second wave has been more intense, the economy is holding up better,” she said. Any recovery will be contingent on the vaccination drive being successful too. Right now, 4% of the population has been inoculated, and it is expected that 60% of all adults will be vaccinated by next March. “The Reserve Bank of India (RBI) is also likely to keep monetary conditions loose so as to nurture growth momentum once COVID-19 infections start to flatten out,” she added.
India is facing a number of headwinds though. For example, Sahay was bearish about the Rupee over the medium-term warning it could be negatively impacted by an increase in oil prices. Similarly, other risks beyond just COVID-19 could derail the country’s growth - namely rising inflation; hardening bond yields; excessive government debt; and limited manoeuvring room to implement a fiscal stimulus. Despite these challenges, Jigar Shah, CEO at Maybank Kim Eng, said there were a number of bottom-up stock-picking opportunities available for investors in a variety of diverse sectors including software, telecommunications, cement, tractors and private banks. In particular, he said that software and telecommunications had been among two of the very few sectors to benefit from the pandemic. Overall, fears about overheating equity markets – especially in the US – together with the unprecedented low interest rates – are forcing investors to seek out returns elsewhere, in what could benefit India.
Reforms pay dividends for India
A market that was historically very difficult to access, India has since opened up to foreign investors following the introduction of the FPI (foreign portfolio investors) regulations. Under the original liberalising measures, foreign institutions – depending on their nature – were designated as either Category 1, 2 or 3 investors. The number of FPI categories has since been rationalised by the Securities and Exchange Board of India (SEBI) from three to two, making it easier for foreign institutions to participate in the country’s domestic market. “The main differences between Category 1 and Category 2 FPIs are that the former tend to be subject to greater regulations and are based in FATF (Financial Action Task Force) jurisdictions. They are also probably safer from a risk perspective too,” said Prashant Khanchandani, director, Transaction Banking, Securities Services Sales at Standard Chartered. He continued that Category 1 investors typically comprised of government institutions (e.g. central banks, sovereign wealth funds, multilateral institutions); banks, broker-dealers, swap dealers, pension funds, insurance/re-insurance companies and asset managers. Meanwhile, Category 2 investors will include endowments, corporates, family offices, individuals, private banks and unregulated fund managers.
India has made huge strides by making it simpler for foreign investors to trade in the local market. For instance, know-your-client (KYC) rules for Category 1 FPIs have been streamlined, while restrictions on issuing and subscribing to offshore derivative instruments (ODIs) such as p-notes were also lifted. However, these provisions do not apply for Category 2 FPIs. “Additionally, Category 2 investors face tighter limits in terms of their holdings of stock derivatives,” said Khanchandani. Under the rules, Category 2 investors are subject to 10% market-wide position limits on stock derivatives, compared to 20% for Category 1 entities. However, Khanchandani said that although FPIs in non-FATF markets could not avail themselves of the Category 1 designation, SEBI recently made an exemption for FPIs located in Mauritius and the UAE in what is further evidence of the country’s flexibility and determination to attract inward flows. These reforms have been vital in helping attract capital to India.
Owing to the country’s positive return potential and impressive market reforms, FPI flows into Indian equities have been strong. Data shows FPI exposures to domestic equities grew by $105 billion between September 2020 and March 2021, bringing total holdings up to $555 billion.1 This puts India in a strong position relative to other emerging markets, a number of whom have suffered pandemic-induced foreign investor withdrawals. “Global markets have performed strongly, and India is no exception. We saw a number of new investors – 9 million in total – register in India over the last 10- 12 months which is phenomenal,” said K Hari, chief business officer at the National Stock Exchange of India Ltd.
Understanding India’s intricacies
In order to maximise success and navigate risks seamlessly in countries such as India, institutions need to work with strong providers who understand the intricacies and dynamics of the local market. Having integrated the prime services business with its custody arm back in 2019, Standard Chartered is in an excellent position to support institutional clients’ bespoke requirements by providing them with a consolidated offering incorporating custody and post-trade together with portfolio risk management and prime financing. “This Joint Venture between prime services and our custody network means we now have a single product offering, which is great news for clients and ourselves internally,” commented Brett Reeves, executive director, prime services sales at Standard Chartered.
1 The Times of India (April 21, 2021) FPIs stock holding value soars by $105 billion in September-March - report