After two days of animated debate, the Lok Sabha voted in favor of Foreign Direct Investment (FDI) in retail yesterday. Sensex has rallied about 5% during last week in anticipation of favorable outcome from the parliament. This coupled with other recent reform measures announced by the government probably marks the beginning of the much needed second generation economic reforms in India.

The first phase of economic liberalization in India started in July 1991. This culminated in opening for international trade and investment, deregulation, privatization and tax reforms. As the old adage goes “Necessity is the mother of invention”. While a serious economic crisis (balance of payment problems) forced Indian Govt. to kick-start the first phase of liberalization, the situation is no different now. An unsustainable current account deficit of more than 4% and a Fiscal Deficit of close to 6% in FY12 and a stubborn inflation of above 7% created a compulsive case for second phase of economic liberalization in India. In September 2012, the Government responded with announcement of FDI in retail, aviation, broadcasting and insurance.

Impact of Economic Liberalization

Capital Flows
The Economic Liberalization in 1991-92 triggered healthy inflow of both FDI and FII into Indian market as shown in the table below.

 

 

 

 

 

 

* FDI inflow data for FY12-13 is till September 30, 2012
** FII inflow data for FY12-13 is till December 04, 2012
Source: DIPP, Newswire 18

Growth Rate
Annual GDP growth rate has taken off from earlier level of sub 4% to 7%-9% during last 10 years.

Source: Newswire 18

Forex Reserves

India has come a long way since June 1991, when it had a foreign exchange reserve of less than USD 1 billion (adequate to cover only 2 weeks of imports) compared to reserves of close to USD 300 billion (adequate to cover imports for 7 months).

Impact on Indian equity market

Since the liberalization began in 1991-92, in spite of stock market scam (in 1992 & 1999), Asian Financial Crisis (in 1997), the Dot Com bubble bust (in 2001), Subprime crisis (2008-09) and ongoing European debt crisis, Sensex has given a CAGR return of close to 20% over last 10 years (between October 2002 and September 2012), one of the best returns across various asset classes among the world markets. This has been well supported by structural Indian growth story and fuelled by flow of foreign capital to Indian capital markets.

Conclusion

As per a CRISIL Research estimate, FDI inflow of USD 2.5 – 3.0 billion is likely if FDI in retail is permitted in all the states. Apart from the direct capital inflow, promotion of organized retail shall help debottlenecking of farm/manufactured product supply infrastructure, lead to lower wastage and thus lower inflation. Moreover, the much awaited policy reforms shall boost market sentiments and sustain the recent uptrend in equity markets.

By: Nirakar Pradhan, CFA, Chief Investment Officer, Future Generali India Life Insurance Co. Ltd.