Foreign investors pulled out over Rs 30,000 cr from the equities during July-August after govt levied the tax surcharge on FPIs.
Despite the government announcing its decision to rollback the surcharge on foreign portfolio investments and relatively accommodative monetary policy stance, inflow of foreign funds into India will remain subdued in the near to medium term, according to a report published by India Ratings.
The report said that countries with positive current account balance (CAB) play a crucial role in supplying capital to countries like India, which structurally runs a negative CAB. The capital flows from these nations enable countries with a current account deficit to finance their trade deficit.
"The weakening of foreign capital flows, therefore, has an adverse impact on the market liquidity conditions of such countries. This affects the cost of financing and constrains the financial flexibility of borrowers, especially private sector players," the report by Ind-Ra, a unit of global rating agency Fitch, said.
Weak demand growth in major economies, geopolitical and trade tensions and a gradual weakening of the economic growth prospects in India have lead to risk aversion, which has hindered the demand for emerging market debt instruments, the report said.
"Amidst weak domestic institutional appetite, the agency believes that tepid FPI flows could put pressure on the domestic yield curve over the medium term, especially on account of large central and state government borrowings in the second half of the year," the report said.
China reported an increase in its surplus in the quarter ended March 2019, the overall trend in the current account surpluses of the seven largest economies (by positive CAB) depicts a weakening of the trade surplus.
China would continue to crowd out capital flows to emerging markets like India and consequently, FPI inflows would remain under pressure, it added.
A continued shrinkage in China’s trade surplus is likely to transform the country from an exporter of capital to a net importer of foreign capital. China’s current account surplus shrunk to around 0.2 percent of the GDP from 2.93% in March 2015.
"Although the current account surplus is still above 0.2 percent, the shrinkage has been accompanied by a large quantum of debt flows into China, driven by continued Chinese policy action towards stimulating domestic consumption," the report said.
Consequently, in the absence of any meaningful pick-up in global trade flows, the surpluses could remain under pressure, leading to further weakening of capital flows to current account deficit economies like India, the report said.
The report also says that due to an environment of economic slowdown, the combined market borrowing by the central and the state governments are expected to be about Rs 6.35 trillion between September 2019 and March 2020.
"Therefore, in case demand continues to be tepid through the second half of FY20, the benchmark G-Sec yield curve could come under pressure. This would lead to a further rise in financing costs for private sector borrowers," the report said.
Capital market borrowings account for Rs 7 trillion of the total debt of the top 500 debt-heavy corporates. The inability to refinance their capital market debt maturities compel corporates to increase the share of borrowings from banks.
"Additionally, as liquidity in the debt capital market remains scarce, even in cases where corporates secure financing from banks, the cost of capital is likely to remain elevated," the report said.
Sectors such as power, metals and telecom, which historically have had a combination of high capital market borrowings and modest liquidity scores, could be affected by the weak capital market conditions.
"Players in these sectors could report higher costs of funds over the near to medium term due to the narrowing of the gap between the banks’ lending rates and bond market yields. For many of these sectors, securing of financing from the banking sector could be challenging, thereby aggravating the liquidity pressures in these sectors," the report said.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.
