The outflow from India-focused funds reached an alarming rate in May amid concerns about the sharp fall of the Indian rupee against the dollar and sluggish policy reforms from the government, according to a report.
Investors reportedly withdrew $370 million from the funds in May, adding to the $334 million in April, according to the Economic Times. The main concern has been the rupee, which has fallen sharply against the dollar since March and has been badly affected by the macro-economic issues faced by the country. Most importantly, the current account deficit widened to 4.3 percent of gross domestic product last year and fiscal deficit is 5.1 percent.
The mounting deficit has become a serious concern for the policymakers. In April, credit rating agency Standard & Poor's cut India's outlook on the long-term rating to negative from stable, saying that the country's economy was facing high fiscal deficits and a heavy debt burden.
According to the Reserve Bank of India (RBI), the country's growth story remains intact in spite of the twin deficits. In April, the central bank stressed that there was no likelihood of a repeat of the situation in 1991 when India faced a balance of payments problem as a result of large fiscal spending in the previous years.
However, the slump in economic growth has become a major worrying factor for the country's policy makers. The economy grew 5.3 percent in the fourth quarter ending March 31, which was a nine-year low and was a major retardation from the quarter ending December 31 when the GDP growth was 6.1 percent. In the July-September quarter, growth was 6.9 percent. The country saw annual growth of 8.4 percent in the last two fiscal years.
The current political gridlock is another factor that adds to the concerns of the investors. Economic analysts are of the opinion that the Indian government's ability to implement policies has weakened due to the slow and complex decision-making process.
Gross fixed capital investment fell outright in year-on-year terms for a third successive quarter. It also fell to 30.9 percent of the GDP, from 34 percent in the same period two years ago. This decline in investment is partly a result of higher interest rates, which have caused credit growth to slow.
In addition, many large projects have been postponed or canceled due to lack of approval for land acquisition, particularly in the steel and power sectors. Some large electricity generation projects have been postponed due to concerns about coal supplies, and this in turn is leading to power shortages for the manufacturing sector.
Business surveys for April suggest that manufacturing and services sectors witnessed slower activity compared to the last quarter of the fiscal year 2011-12, and the growth of domestic credit remained sluggish in April.
In addition, external demand has remained weak. The euro zone GDP will almost certainly have contracted again in the second quarter and growth in China has been disappointing. Finally, the RBI's recent 50 basis point rate cut is not enough to make a material difference to private sector consumption or investment.
Meanwhile, on a positive note, the government has stepped in to take the initiative to make sure that investor confidence is regained. The Indian market improved this week with the rupee strengthening to a certain degree amid the hope that the RBI will intervene to ease the monetary policy, which will in turn boost economic growth.
Comments by Union Finance Minister Pranab Mukherjee and RBI Deputy Governor Subir Gokarn earlier this week on India's financial condition and possibilities of monetary policy easing helped strengthen positive sentiments among market players. Besides, Prime Minister Manmohan Singh has promised to push for infrastructure development, which will be critical for the economic growth.