Capital outflows to the tune of $100 billion (around Rs 7,80,000 crore) are likely to take place from India in a major global risk scenario or a black swan event, says a Reserve Bank of India (RBI) study.
There is a 5-per-cent chance of portfolio outflows from India of the order of 3.2 per cent of GDP or $100.6 billion in a year in response to a Covid-type contraction in real GDP growth or a GFC (global financial crisis) type decline in interest rate differentials vis-a-vis the US or a GFC type surge in the volatility index (VIX), the RBI study said.
“In an extreme risk scenario or a black swan event in which there is a combination of all these shocks, there is a 5 per cent chance of outflows under portfolio investments of 7.7 per cent of GDP and short-term trade credit retrenchment of 3.9 per cent of GDP,” said the RBI study on ‘Capital flows at risk’.
According to the RBI report, these estimates assume significance when assessed against the total stock of portfolio investment in India of $288 billion and short-term trade credit of $110.5 billion at the end of December 2021.
“This is indicative of the level of liquid reserves that need to be maintained at all times — in addition to standard metrics of import and debt servicing cover — to quell bouts of instability that volatile capital flows can impose in a dynamic and highly uncertain global setting in which pandemics, supply chain disruptions, and elevated commodity prices and geopolitical tensions keep interacting and intertwining,” it said.
According to NSDL data, foreign portfolio investors have pulled out a record Rs 2,08,587 crore ($26.75 billion) from the Indian markets in calendar year 2022 so far. Of this, as much as Rs 1,98,585 crore was withdrawn from the stock markets in the wake of the global monetary tightening led by the US Federal Reserve to tame inflation and the negative impact of the Ukraine war.
Stock markets have plummeted by around 17 per cent since the October 2021 peak of the indices, largely on account of the FPI withdrawals. Soaring inflation in the US and other advanced economies is likely to lead to more rate hikes in these countries, analysts say.
“With the spate of emerging market crises since the 1990s and the experience with the global financial crisis and its aftermath, attention has turned from the benefits associated with capital flows to their consequences such as accentuating financial vulnerabilities, aggravating macroeconomic instability and spreading contagion,” the RBI study said.
For India, portfolio flows are the most sensitive to shifts in risk sentiment globally and spillovers. Equity flows have tended to be more volatile than debt flows and associated with large outflows during the Global Financial Crisis, the taper tantrum, the US Presidential election of 2016 and Covid-19.
The report said debt flows turned negative with the onset of the pandemic. “The tapering announcement by the US Fed in May 2013 led to heavy outflows by foreign portfolio investors from both equity and debt markets, and especially from the debt segment,” it said.
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Similarly, global risk aversion driven by the outcome of the US Presidential elections and expectations of an increase in the Federal funds rate culminated in intense selling pressure in equity and debt segments from November 2016 through January 2017, it said.
The RBI’s findings suggest the predominant role of pull factors in attracting capital flows to India, key among them being growth differentials and domestic term premia. On the other hand, it is global risk aversion, reflected in the VIX, which drives capital outflows.
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Clearly, Bretton Woods type prescriptions such as tightening of monetary and fiscal policies, exchange rate adjustments and structural reforms in some kind of pecking order as a hierarchy will not work, it said. In the ultimate analysis, spillovers can be global, but the responsibility for macroeconomic and financial stability is national. This focusses attention on the role of international reserve accumulation as the only reliable safety net, the RBI study said.
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