Session 4: Macroeconomics and Finance

Chaired by Subir Gokarn from Brookings India, the session on Macroeconomics and Finance covered two research projects on capital flows in India, in particular foreign fund flows and borrowing in foreign currency. The first one, from Kiran Kumar (Indian Institute of Management, Indore) focuses on foreign fund flows and stock returns in India. Dividing firms in those with low and high innovation portfolios, the author finds that for high innovation portfolios returns reversal is less persistent, and returns are driven by differences in innovation in FII flows. This means that stocks with high innovations are associated with a coincident price increase that is permanent. On the other hand, stocks with low innovation are associated with a coincident price decline that is in part transient, reversing itself within two weeks. The results are consistent with a price “pressure” on stock returns induced by FII sales, as well as information being revealed through FII buys and sales. Moreover, the author concludes that there is a trade-off in the effect of FII flows on stock markets: while FII outflows contribute to transient volatility for stocks experiencing the outflows, trading by FIIs also generates new information. In addition, the price pressure effects are increasing in FII flow surprises and global “stress”. K.P. Krishnan (Dept of Economic Affairs, Ministry of Finance) stressed that FIIs are usually analysed in India as a single monolithic entity that centrally driven (partly as a result of data availability), which limit researchers’ ability to evaluate the effects of potential arbitrage opportunities among different subcategories. During the Q & A session, the issue on the differences between foreign and domestic flows was commented, as well as whether the efficient market hypothesis and the degree of risk sharing and consumption smoothing could be tested in India.

The second presentation, “Understanding foreign currency borrowing by firms”, Nirvikar Singh (University of California, Santa Cruz) assesses borrowing abroad and the degree of home bias in India estimating propensity score matching and a Tobit model using data of non-financial firms from 2001-2013 with sales greater than USD$1 million. Not surprisingly, but important, larger firms borrow a greater share of its total liability in foreign currency as they usually have better collaterals and liquidity position. At the same time, the percentage of firms naturally hedged through exports have increased to about 50% of the sample total, making foreign borrowing less risky on average; but inability to hedge limits the benefits of foreign borrowing for a sizable number of firms. Moreover, the researcher concludes that borrowing abroad has an impact on fixed asset growth, but this does not mean a sharp increase in output growth or export growth rates which would be expected in the cases of financially constrained firms. K. P. Krishnan commented on the policy implications this may have. If all firms were able to increase fixed assets by a few percentage points, similar to the growth rate achieved by firms borrowing abroad, this will translate in an overall increase in the country’s output and productivity. This raises the issue of facilitating external borrowing and opens the question of capital control from another perspective than the one normally discussed.

By Michelle Tejada, Hub Economist, IGC Hub