Why were FIIs being bearish?
If the period between the last quarter of 2016 and early 2017 was anything to go by, FIIs were quite bearish, both in debt and equity. Between October 2016 and end-January 2017, FIIs were net sellers in the debt and equity segments at ₹48,406 crore and ₹31,903 crore, as per data from the National Securities Depository (NSDL).
The equity segment saw selling by FIIs on expectations that the new government in the U.S. under President Donald Trump would take fiscal steps to boost growth even as interest rates trended higher, thereby making the other markets relatively less attractive. Incidentally, the U.S. Federal Reserve raised rates by 0.25% on March 15, only the third such increase in a decade.
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There was some amount of profit booking in the equity segment on account of demonetisation as well, which is expected to dent corporate earnings over the next few quarters.
Portfolio management firm Sanctum Wealth attributes the outflows in the debt segment to the infusion of fresh deposits in the banking system that is likely to bolster demand for government bonds at banks, which augurs well for bond prices but makes debt less attractive for yield investors. The narrowing of the rate differential is likely to keep foreign investors on the sidelines, it said.
What makes FIIs so important?
FIIs have been the prime drivers of every bull run in the Indian equity market. They have been attracted by the handsome returns and the robust regulatory and trading mechanisms of the country for long. Data on foreign flows in the Indian equity and debt segments are available from 1992-93, and since then, they have invested ₹8.51 lakh crore in equities and ₹2.82 lakh crore in debt. Interestingly, between 1992-93 and 2015-16, there have been only three financial years (1998-99, 2008-09, 2015-16) when FIIs ended the fiscal period as net sellers of equity. In the debt segment, they were net sellers on five occasions.
Within the Asia ex-Japan pack, India traditionally features among the highest recipients of foreign money.
When will foreign flows stabilise?
Going by the data for the past two months, it seems the outflows have stabilised for now. Data show that foreign investors have been net buyers of Indian debt at ₹17,630 crore in February and March. In equities, they have been all the more bullish, putting in a cumulative amount of ₹30,863 crore in this period. But a section of market analysts feels that it is too early to conclude that the trends have changed as the past two months have seen a reversal in flows across all emerging markets, not just India. For instance, while India has seen inflows of $4.6 billion in the current calendar year, as per Bloomberg data, South Korea and Taiwan have also seen inflows in excess of $4 billion. Further, Indonesia and Malaysia have seen inflows of $455 million and $961 million respectively.
There is a view that the flows started reversing by January-end on increasing expectations that growth in the U.S. would accelerate, which would have a ripple effect on the emerging markets too. Historically, a strong growth acceleration in the developed markets has led to emerging markets being significant beneficiaries. This time though, analysts are taking a cautious view as the Trump administration has talked about trade restrictions and punitive import duties while calling domestic companies to manufacture more in the U.S. Much would depend on the valuations as the recent surge has made Indian markets expensive in both the relative and absolute sense. Based on parameters like price earnings and price to book returns, India looks about 40-50% higher than the regional average.
Finally, corporate earnings would also be an important factor to decide the course of foreign flows. Currently, there is hardly a bullish view on earnings growth as many are expecting a hit from demonetisation and global economic momentum is yet to decisively strengthen. Incidentally, the recent surge has entirely been due to liquidity as investors have been betting on equity on the back of a strong mandate for the ruling political party. So, from an economic point of view, a combination of slightly cheaper valuations and consensus growth in earnings are the key to continued foreign flows.