View From The Road: What Foreign Investors Want

Even as the media debates over how the retention or exit of RBI Governor Raghuram Rajan this September will impact foreign investor sentiment, it is worth looking at the factors that influence investment decisions.

Over the last year, I have been travelling to several countries and meeting investors, mostly of the institutional kind. From Japan to the USA and the regions in between, the dialogue is top-down. Typically, it begins with India’s Prime Minister Narendra Modi (always by his name : Mr Modi, Modi-san!), his dynamism, his active geopolitical presence and the overall buzz of an Indian turnaround story conveyed by the financial media and analysts.

In Japan and the Gulf Cooperation Council (GCC), executives allude to their government’s signals sent internally with regard to India. For example, an executive I met from a major Japanese corporation mentioned calls from the Japanese Prime Minister to company CEOs urging them to expand in India aggressively. In another example, a senior UAE Sovereign Wealth Fund (SWF) executive talked about a strategic commitment of US$ 70 billion to India based on a new alliance between the two countries. From here, the discussion goes down to industries and sectors and curiosity about `Make in India’, Internet penetration, infrastructure and the growth trends within each sector. Finally, the focus turns to specific opportunities.

Sandwiched between the opening macro view and the sector topic is a wincing expression and shuffling of feet as people remember the great fall of the Rupee. This then segues into talking about bad experiences in India during the last investment boom of the 2000s. Investors piled into India on the back of strong, stable macroeconomic performance whose lag effect petered out during UPA 2.These are investors who have invested both in the Indian public markets (as FIIs) and in private equity funds/operating companies (FDI).

So what do investors really care about? Essentially, Risk Adjusted returns. And an assessment of potential returns and perceived risks takes them deep and wide. There are many criteria or filters that investors use to assess and make their investment decisions with respect to a country. Here are the Top 10 filters that I have observed, but in no particular order of priority.

1. Stability of government. Investors want to see stable governments and typically pay a governance premium for functioning democracies. This was one reason why investors greeted UPA-2 with enthusiasm. And why investors have greeted NDA-2 with exuberance. Stable, good governance over time will help cast the net wider over a larger universe of investors who are willing to invest for lower returns, given lower perceived risk. This significantly expands the pool of capital available to India.

2. Fiscal health. Fiscal discipline goes a long way in addressing concerns about the future health of an economy. When policies and action show the government in a responsible light, investors respond favorably. Where governments are seen as profligate spenders, this has a reverse effect. India is seen to be doing a stand-out job with managing its fiscal deficit.

3. Quality of governance. Investors judge this through proxy indicators. Crony capitalism and corruption indices are useful in understanding these trends. Then again, investments in infrastructure (roads, seaports, power, energy, airports) send positive signals of sustainable GDP growth. Similarly, when regulators get empowered, this sends a comforting signal. SEBI and RBI have traditionally been viewed as good regulators. India’s intellectual property (IP) regime has not been viewed favourably and some action is anticipated here.

4. Certainty of regulation. This is a big one. India’s recent history of retro-taxation is a massive deterrent. Investors must have no anxiety over whether they can take their legitimate gains out of the country and keep them. The recent change in the Mauritius agreement sends out both clarity and certainty. Once we slay the retro-tax beast and leave no shadow of doubt in investors’ minds, investors’ confidence will grow.

5. Trajectory of GDP. Yes, GDP numbers can be hard to interpret but smart investors have the ability to `suss out’ numbers, whether it is India’s GDP or the US unemployment figures. Across all economies, numbers published by governments are scrutinised for comparability and accuracy. So while India does not need to flagellate itself on its GDP numbers, it is important to be transparent and consistent in terms of methodology to allow an `apples to apples’ view.

6. Public markets performance, IPOs and volatility. Public markets acquire trading depth and liquidity as corporate balance-sheets grow stronger.India’s corporate sector is in recovery mode from a growth and earnings standpoint, holding back expansion of market capitalisation. Exits through IPOs are watched very closely as a lead indicator of a virtuous cycle. India has a seen a jump in IPOs in the last year. The quality of investments and flows also affect volatility. Hot FII money via participatory notes that made its way to Indian markets under UPA 2 has certainly reduced.

7. Performance and behaviour of the currency. The rupee has been one of the better performing currencies in the last 18 months. This is mainly thanks to FDI and lower current account deficit; not due to any interventions by the RBI. When investors see currency instability, it reflects erosion of their gains and can keep away even patient capital.

8. Pitching by the government. This government has not been shy of proactively reaching out and communicating vision, intent and progress. The lead spokesperson for India has been its Prime Minister and investors love to hear from the leader , company CEO or head of state. As we have seen, the messaging is then carried forward by other CEOs and influencers to generate a deeper effect.

9. Sector specific policy and growth potential. This is particularly true for investors who are mandated to specialise in certain sectors. Or who would like to avoid certain sectors. The experience of investing in Indian infrastructure and real estate has not been pleasant and many investors are following sectors that have stayed the course over time and are disconnected from political or governance risk.

10. Reform and ease of doing business. Reforms that reduce the bureaucratic burden across the investing cycle have an asymmetric impact. Investors must be able to invest, exit their investments and take their money out without having to jump through bureaucratic hoops. This aspect is being grossly underestimated in India today.

The larger point is that the Indian economy is studied from many angles and there is an appreciation for the structural transformation under way. I haven’t listed other determinants such as India’s weight in market indices such MSCI Emerging markets, enforceability of contracts, labour law reform, SME growth and challenges, exports versus domestic markets, digital penetration, consumption trends, demographic dividend, rural economy indicators and so on. In fact, if one were to follow the updates from the government ministries, we hear drumbeats across a variety of macroeconomic, technology and social indicators.

From time to time, we observe a `scare’ narrative (Investors will leave India if…) from media, opposition politicians and various experts around unifocal issues such as the RBI Governor extension or how a MP communicates, or `freedom of expression’ or `religious freedom’. This is hogwash. Investors don’t pay much attention to our petty politics and vested interest groups. They focus on governance. And they have learned to separate the noise from the signal while seeking concrete indicators of progress and performance.

On this count, India has firmly emerged from the doghouse and is on a positive trajectory. Make no mistake. Money has been coming, more of it will come and this will increasingly be long term money. The voice of the investment marketplace is clear. The leadership of Prime Minister Narendra Modi has been the key factor in turning the sentiment around in favour of India.