FDI in Indian Stock Markets: How it Impacts You…the Small Indian Investor?

The Indian government recently opened the gates for foreign individual investors to invest directly into Indian stock markets.

A reader has posted a question on the Safal Niveshak Forum whether the entry of these foreigners will have any impact on investments by small Indian investors in the long run.

Let me first talk a little about the possible impact of the entry of foreign individual investors on Indian markets.

Well, this seems more like a ‘stitch in time’ kind of an attempt by the government than anything that is going to benefit the Indian markets in the long run.

As you know, the Indian rupee has been under tremendous pressure over the past few months. From about Rs 45 per US dollar in July 2011, the rate stands at nearly Rs 53 now.

So, in order to bring some stability to the Indian Rupee, this latest move from the government seems more like an act of desperation. This is because, as the government expects, a greater inflow of dollars from these investors will stop the fall in the rupee’s value.

“But aren’t foreign individual investors already investing in Indian stocks?” you may ask. “So what’s new?”

Well, it’s different. Currently, foreign retail investors can only buy Indian shares through participatory notes or P-Notes – a derivative product that is held offshore by large institutional investors or hedge funds that are not registered with the regulator.

So these investments are currently not regulated and therefore no one in India knows the sources of these funds. This has caused immense volatility in Indian markets in the past whenever these investors (who invested through the P-Notes) have pulled out money.

Now, as per the new rules, these foreign individual investors can invest directly in India through the mutual fund route. So there will be several checks and balances in place to know the real sources of these fund flows.

But will new foreigners invest in India?
Coming to the impact of investments by foreign individual investors, the first thing to ask is – whether these investors will really invest in the Indian markets given the poor perception they might have about India – with their whole host of concerns like economic slowdown, rampant corruption, poor reforms, and shallow financial markets.

So their overall perception about India might not be positive as of now.

Another factor that could deter these investors into investing in India is the volatility of the Indian rupee.

Existing foreign institutional investors (FIIs) have already lost a lot of money in India following the sharp depreciation of the Indian rupee recently.

So the rupee factor would also act as a deterrent to new foreign individual investors.

The government is saying that this move has been taken to ‘widen the class of investors’, ‘reduce market volatility’, and ‘deepen the Indian capital market’.

This seems funny given that the government isn’t doing much on its part to widen the base of local investors, and is instead worrying about the foreigners who have proved to be ‘fair weather friends’ in the past!

As far as the ‘deepening of Indian capital market’ is concerned, this will happen more through internal reforms and improved safety-nets for existing Indian retail investors instead of bringing in the unknown foreigners.

Impact on small Indian investor
The sudden mood swings of foreign investors have impacted small Indian investors in the past. This is not going to change in the future, whatever the government might say.

This is simply because the existing FIIs in India are largely bothered by what happens in the short term. The really long-term foreign money – like pension funds – hasn’t entered India as yet, and is not coming here till the government puts its house in order on the reforms front.

So the Indian markets will remain at the mercy of how the FIIs are thinking and acting – however foolishly they might be thinking and acting isn’t really important here!

Given this, there are two ways a small investor can safeguard himself and his investments instead of being at the mercy of foreigners:

1. Invest for the long run
Please note that the real ‘risk’ in stock market investing comes from nothing else but not knowing what you are doing.

So if you buy a stock without studying the company and without knowing whether the price you are paying is right or not, that is the biggest risk you are taking.

The risk on account of activities of FIIs is something that a trader/speculator must be worried about, and not a long term investor.

This is because FIIs are fair weather friends. They buy and sell stocks with great rapidity, just because they need to ‘show’ some kind of performance to their ultimate clients.

You, as a small investor, have an advantage in this respect because you need not worry about someone else’s returns and must concentrate on what is good for you.

So, just ignore what the FIIs are doing. In fact, when these big investors are panicking, it gives you all the more chance to pick up your favourite stocks cheap.

2. Invest in stocks with good liquidity
This is another factor that you must take into account. A stock that is illiquid (less traded volume) is highly volatile, as even a single FII activity can create sharp movements in its price.

So, invest in stocks that are traded in reasonable quantities on the stock exchanges. You can get the ‘traded quantity’ data on BSE’s website.

In the long term, what will really impact your investment returns isn’t the emotional outburst of the foreign investor, but how you take care of your own emotions and use them to your advantage to play this game of greed and fear.