Neelkanth Mishra: Strong growth, but FPIs still have reasons to stay away from India

The latest market report highlights that India's economy is gaining momentum, corporate earnings expansion stays solid and the indian rupee has stabilised. Yet foreign portfolio market participants have both structural and tactical reasons to stay wary on Indian equities, according to Neelkanth Mishra, Executive Director, The World Bank Group.

In an exclusive conversation with Moneycontrol, Mishra stated, the structural problem is a reversal in the relative cost of capital between India and the rest of the world.

India's fiscal discipline has helped bring down its domestic cost of capital—a positive development for entrepreneurs, businesses and asset prices. But the global cost of capital has risen at the same time, changing the gradient that had previously pulled money toward Indian assets.

Mishra likens the shift to the flow of water. When risk-free rates in India were around 8% and those in developed markets were closer to 2%, capital naturally moved in one direction. Now, rates that were around 2% have risen to around 4.8%, while India's have fallen from around 8% to 6.8%.

On a currency-hedged basis, the relative economics of deploying capital have as a result changed.

That shift has become particularly important because Indian equities trade at high price-to-earnings multiples, making the market look expensive to foreign market participants.

Yet Mishra sees another side to India's valuation premium. High equity prices reduce the cost of capital for firms and encourage entrepreneurs to mobilize primary capital through public markets.

The thick pipeline of IPO announcements is evidence of that process at work.

From a secondary-market perspective, the resulting demand-supply imbalance can be a challenge. From an economic perspective, that stated, Mishra says this is how capital markets are supposed to function: equity prices climb, the cost of capital falls and more businesses seek primary capital.

Over time, India's valuation premium could even encourage foreign firms to consider stock-exchange debut in the country, adding to the supply of securities available to market participants.

During the past year, foreign market participants have additionally had to contend with currency risk.

The earlier bout of volatility triggered considerable anxiety, with Mishra pointing to roughly $5 billion of asset hedges being taken toward the end of the panic—a measure of the level of fear in the market.

That problem has eased following FCNR(B) inflows, which have helped stabilise the indian rupee and stem what he describes as the run on the currency.

But oil has now emerged as the more immediate risk.

Foreign outflows have picked up again of late, something Mishra describes as logical, although not desirable, should crude stay close to $100 a barrel.

The concern is that geopolitical developments could keep prices elevated for longer. Attacks involving oil assets and tankers raise the risk that disruptions could begin affecting energy infrastructure and supply, making a prolonged period of expensive crude more likely.

For an oil-importing economy such as India, that would naturally make the market less attractive to overseas market participants.

The result is a two-part challenge for foreign flows: a structural shift in the global cost-of-capital gradient, followed by the tactical risk of elevated crude prices.

Beyond those factors, that stated, Mishra sees little cause for concern in India's domestic fundamentals.

Corporate earnings expansion is solid. Visibility on GROSS DOMESTIC PRODUCT expansion stays firm and the momentum in economic activity is holding up. The currency market has additionally stabilised.

For now, then, India's paradox stays intact: the economy and its underlying fundamentals are looking increasingly healthy, while the forces determining global capital allocation keep keep foreign market participants on the sidelines.