Foreign portfolio investors have pulled out Rs 42,000 crore this month amid rising inflation and monetary policy tightening in the US.
- FPI involves an investor buying foreign financial assets such as fixed deposits, stocks, and mutual funds. All the investments are passively held by the investors.
- Capital flight is a phenomenon characterized by large outflows of assets/ capital from a country due to political or economic instability, resulting in negative economic consequences to that country.
Reasons for capital flight
- The tightening of monetary policy by the US Fed
- Rate hiking by other central banks, including in Britain and the Eurozone
- An appreciating dollar
- Concerns regarding the possibility of a recession in the US
- Rising inflation
- In times of global uncertainty, foreign investors embrace a risk-off trade, meaning they move money from risky assets such as equities and add more of bonds and gold.
- When interest rates rise in the US and other advanced economies, they withdraw money from emerging markets such as India and invest in the bonds in their domestic markets.
How does the capital flight affect the markets and the rupee?
- Capital market- The pullout is dampening sentiment in equity and forex markets.
- The impact of FPI selling on markets is visible with increase in volatility and declining equity prices.
- Forex- India’s foreign exchange reserves have fallen $596.45 billion as on June 10, 2022, mainly due to the dollar appreciation and FPI withdrawals.
- Depreciation- The rupee has plunged 7.3% to an all-time low of 78.30/32 against the dollar.
- If the rupee does not strengthen, FPI outflows will continue, which is another negative.
- Inflation- Lower rupee against the dollar keeps import bills higher, pushing inflation even higher than it is now.
- Indians abroad- Travellers and students studying abroad will have to shell out more rupees to buy dollars from banks.
- Fuel price- People are directly impacted by the rupee fall as fuel prices shoot up.
- DII inflow- The retail flow and domestic institutional investors (DIIs) inflow is weakening now, and the markets could weaken further if the FPI outflows continue.
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