To put this in the context of the rest of India’s balance of payments in October-December 2008, we see that foreign institutional investors (FIIs) came second, pulling out $5.78 billion from India. Much has been written about FIIs who faced pressure from clients to redeem investments and who were pulling money out of emerging markets to help out their headquarters that were in dire straits. Banking capital also changed direction and accounted for another $4.95 billion flowing out of India, as banks, including Indian banks operating abroad, moved capital around the world to London and New York where they faced shortages. For the rest, the inflows of loan and foreign direct investment into India fell by about $2 billion each. Considering the condition of financial markets in the US and Europe, this was hardly surprising. All this put together led to a net outflow of capital from the country.

The large outflow of FDI from India at a time when the financial system was reeling under a huge liquidity crunch demands explanation. In normal times, an outflow of FDI from India would have been explained by Indian companies buying companies around the world. However, the October-December 2008 quarter was one of extreme pain and lack of liquid funds around the world, and it was not a time when there was any greenfield investment or any mergers or acquisitions by Indian companies.

The explanation appears to lie in the operations of existing Indian multinationals. There are nearly 250 Indian multinationals today. These are Indian companies ranging from the Tatas to IT firms to smaller automobile component firms who produce abroad. These companies used global money markets in normal times wherever they were — in London, New York, Munich or Singapore. Immediately after the death of Lehman, when global money markets froze, they took money out of India to meet the needs of their businesses in the rest of the world. Indeed, when we look back at what happened in Indian money markets and in the rupee-dollar spot and forward markets, we find further support for this story.

... contd.