Since the high of the indexes in October 2021, the markets have fallen by almost 17%. Taking the current volatile situation into consideration, a black swan event might just trigger $100 billion capital outflows from India, warns the RBI.
According to a Reserve Bank of India (RBI) assessment, India is expected to experience capital outflows of up to $100 billion (about Rs 7,80,000 crore) in the case of a large global risk scenario or black swan occurrence.
A Covid-type contraction in real GDP growth, a GFC-style narrowing of interest rate differentials with the US, or a GFC-style spike in the volatility index (VIX) all carry a five percent possibility of triggering portfolio outflows from India of the size of 3.2% of GDP, or $100.6 billion in a year.
“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’.
The RBI research states that these projections take on relevance when compared to the $288 billion total stock of portfolio investments in India and the $110.5 billion short-term trade credit 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.
NSDL records show that as of today, foreign portfolio investors had withdrew a record Rs 2,08,587 crore ($26.75 billion) from the Indian markets. In response to the global monetary tightening initiated by the US Federal Reserve to control inflation and the negative effects of the Ukraine war, as much as Rs 1,98,585 crore of this amount was pulled from the stock markets.
Since the high of the indexes in October 2021, the markets have fallen by almost 17%, primarily as a result of FPI withdrawals. Analysts predict that rising inflation in the US and other advanced economies will result in more rate increases in these nations.
“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.
The portfolio flows for India are the most susceptible to changes in global risk sentiment and spillovers. The global financial crisis, the taper tantrum, the 2016 US presidential election, and COVID-19 were all times when equity flows were significantly higher than debt flows and more volatile.
According to the data, debt flows started to decline as soon as the pandemic started. “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.
Similar to this, it was said that from November 2016 to January 2017 there was a strong selling pressure in the equities and debt segments due to global risk aversion brought on by the outcome of the US Presidential elections and predictions of a hike in the federal funds rate.
According to the RBI’s research, pull factors—particularly growth differentials and local term premia—play a major role in drawing capital to India. On the other hand, the VIX, which measures global risk aversion, is what propels capital outflows.
It stated that it is obvious that the Bretton Woods-style recommendations, such as tightening monetary and fiscal policies, adjusting exchange rates, and implementing structural reforms in a hierarchy or pecking order, will not be successful. In the end, spillovers may be global, but national governments are in charge of maintaining macroeconomic and financial stability. According to the RBI analysis, this draws attention to the importance of international reserve building as the sole trustworthy safety net.