What lies ahead for Indian equities after a sustained FII exodus in first half?
FII sell-off | Taming inflation, freezing interest rates and a decline in recession expectations backed by better GDP data in developed markets could help reverse the trend of FII flows.
Indian equity markets continued to be battered by the incessant selling pressure exerted by the FIIs/FPIs (foreign institutional investors / foreign portfolio investors) for the ninth month in succession. This is by far the longest selling streak by FIIs in the Indian markets.
Though the DIIs (domestic institutional investors) have provided massive support to the markets and have tried their best to match their buying with FII selling, the indices are down more than 15 percent from their all-time high hit on October 19 last year.
The FII selling which initially started due to the fear of interest rate hikes and liquidity taper by the US Federal Reserve was further exacerbated by the start of the crisis in Eastern Europe when Russia launched an offensive on Ukraine.
With global markets largely reliant on these two countries to meet their food, commodity, and energy requirements, the world was suddenly faced with the prospect of a shortage as the West imposed punishing sanctions on Russia with an intention to dissuade that nation from continuing with the war.
The sanctions led to a steep surge in global crude and commodity prices. The one major fallout of the war is that the global economy is now facing a rapid rise in inflation across geographies. As central banks try to tame inflation by resorting to aggressive hikes in interest rates, bond yields have been rising consistently. Also, the concerted efforts to rein in inflation have given rise to concerns about slowing economic growth. In April, the International Monetary Fund slashed its global GDP growth rate forecast for 2022 to 3.6 percent compared to an earlier estimate of 4.4 percent.
Given the rise in bond yields and uncertainty about the overall health of the global economy, FIIs are moving their money to safe havens rather than staying invested in risky and tricky equity markets.
This is evident from the fact that foreign investors have pulled out close to Rs 50,000 crore from Indian markets in June as per data available on NSDL. This makes the withdrawals in the month the second highest since March 2020.
Total withdrawals from the secondary market by foreign investors during the first half of 2022 stood at a staggering Rs 2.24 trillion (1 trillion = Rs 1 lakh crore).
When we will see a reversal in trend
Experts are of the opinion that Indian investors will continue to feel the pain for another few months before seeing a respite in selling by foreign funds.
“FIIs should reverse course by Q3FY23 as the inflation has started to peak; food prices and metal prices have seen a significant reversal, China is now opening up its industries and its manufacturing activity has begun to pick up,” said Divam Sharma, founder, Green Portfolio.
Narendra Solanki, head, equity research (fundamental), Anand Rathi Share and Stock Brokers agreed: “I think by the second half of the current year FIIs should again come back to the markets as markets are now expecting the macro environment to improve globally by the second half of the current year.”
The direction in which the rupee moves will also play an important role in reversing the prevailing trend.
“The Indian rupee is the weakest it has ever been and FIIs will start entering the country once the rupee is in the 70 to 72 range,” said Suman Banerjee, CIO, Hedonova, an alternative investment firm.
However, these are short-term sentiments. The growth outlook for India remains robust. Whether it is high inflation prints or RBI interest rate hikes, these short-term factors will not derail India’s growth, experts said.
“Once the interest rate hike uncertainty fades, followed by the peaking of inflation, FIIs will be pouring back into India,” said Sharma of Green Portfolio.
Drivers for trend reversal
A return of foreign money to emerging markets hinges to a large part on inflation and interest rate hikes by central banks.
“Improvement in the global macro environment like peaking of inflation, arriving at terminal rate earlier than expected and decline in recession expectations backed by better GDP data in developed markets could help in change of stance of FII flows,” said Solanki of Anand Rathi.
The ongoing interest rate hikes are orienting FIIs and FPIs alike to sell emerging market securities, as the yield in the US becomes more attractive given interest rate expectations in the US.
“Peaking of inflation abroad and a signal from central banks that they are done with raising rates can be the triggers for FPIs to reconsider coming back to Indian equities,” said Deepak Jasani, head of retail research, HDFC Securities. However, he is doubtful if this will happen in the next couple of quarters.
Outlook for rest of 2022
Though it is always very difficult to predict the markets, experts are cautiously optimistic that the second half of 2022 would witness growth in certain pockets though volatility may continue to rattle overall market sentiments.
Sharma of Green Portfolio is quite positive about the state of markets in the second half as he forecasts a steady recovery in the second half. The valuations of several industries and the broader market have become extremely attractive, he feels.
“Despite indications of a recession in the US, economic data prints and on-ground manufacturing activity in India remain resilient and we believe that the midterm elections in the US would be a positive catalyst for the markets going into the second half,” added Sharma.
Solanki of Anand Rathi sees some more consolidation in the second half with some positive moves in some pockets. “Growth momentum is expected to continue and margins are also expected to show some signs of revival as global commodity prices decline with inflation peaking by the second half of the current year,” he said. However, risks from global markets are likely to continue to create some headwinds.
Jasani of HDFC Securities is more sceptical: “Indian markets in the second half could see lower levels due to technical reasons (FPI sales) and fundamental reasons (high-interest rates locally, possible downgrade in corporate earnings, fiscal issues, etc), although some intermittent bounces cannot be ruled out.”
Banerjee of Hedonova too believes the markets will remain bearish for the remainder of the year. “Inflation is high, which will lead to rate hikes and higher yields on US treasury bonds and will attract capital away from emerging markets like India,” he said.
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