Money is sloshing about in the financial system — and the tide of foreign cash has surged this year.  But the question is: how long will this party last?

Data gathered from the Reserve Bank of India shows that foreign investment flows into the country swelled to $65.5 billion in the first 10 months of this fiscal (April-January 2014-15) from $18.2 billion in the same period a year ago.

Phew! That is an almost 260 per cent rise in foreign investment inflows this year!

Break down that number: net foreign direct investment (FDI) amounted to $30.4 billion in the April-January period against $20.1 billion last year.

Stocks & bonds 

But the real fun and games was in the area of portfolio investment where foreign investors shovel money into stocks and bond markets in that eternal quest for blowout returns.

Net portfolio investment surged to $35.1 billion from a negative $1.9 billion during the same period, translating into a staggering growth of 1947 per cent.

There seems to be a fine balance between net FDI and net portfolio investment — $30.4 billion versus $35.1 billion that would suggest that there is a convergence of views between the so-called long-term investors and the more fickle investors about India’s prospects.

Equities on fire

One reason for this is that Indian equities have been on fire for most of the year, especially after the resounding victory by the Narendra Modi-led BJP in the general elections last May. 

The Sensex  — the market’s bellwether index — rose 27 per cent between April 1 last year and March 13 despite the market wobble in the past few weeks.

India has been the emerging market with the best returns this year and the investment flows into the country bear testimony to that.

Gloomy mood

But the dark clouds now loom.

One big factor is the growing anticipation that the US Federal Reserve will raise interest rates after close to six years sometime in June after a fairly strong set of job numbers. 

The Fed watchers have already started parsing the statements coming out from Janet Yellen and her colleagues, focusing on her overuse of the word ‘patience’ to generally infer that she will hold off for some time more.

But when and if the Fed raises rates in June, world markets will wobble and everyone will be scrambling to understand what its impact might be.

According to the Institute of International Finance (IIF), if the Fed raises interest rates by half a percentage point, money flows into the emerging markets and developing economies (EMDEs), which includes India, will plunge by about 10 per cent or $30 billion.

Flight of funds

The big worry is that every time the Fed has raised rates in the past, money has flown into US bond markets and hurled the EMDEs into a steaming cauldron precipitating a currency, sovereign or a banking crisis.

Although the IIF is predicting that 2015 will be a stressful year for capital flows into emerging markets, some experts are drawing comfort from the fact that both the European Central Bank and the Bank of Japan have been pursuing very expansive, ultra-accommodative monetary policies which could blunt the blow of a US rate increase.

Oil factor

There are two other factors that could wreck the party: a sudden spike in oil and other commodity prices raising the cost of manufacturing in India at a time when the Modi government is trying to push the envelope in its Make in India campaign.

The other is a general deterioration in the global trading environment, which will put pressure on the rupee and have a rub off effect on inflation, which is currently trending at 5.37 per cent and is expected to be capped at under 6 per cent for the greater part of the next fiscal.

Saving grace

One big advantage in India’s favour is its booming forex reserves at $337 billion which is enough to pay for 8.1 months of exports.

“Financial flows in 2014-15 are likely to be in excess of $55 billion, leading to a sizeable accretion to reserves by about $26 billion, to about $340 billion,” says the Economic Survey. 

“These inflows are likely to continue through a large part of 2015-16.”

In May 2014, talk of the Fed taper had sent the rupee into a tailspin. This time round talk of the Fed rate hike doesn’t appear to have spooked the markets as yet. One reason for this is that India has a far more resilient macro-economic position than it did a year ago.  Buttressed by the big forex reserves, India just may be able to ride its way out of trouble.