Sustained selling by foreign portfolio investors is hurting investor sentiment on Dalal Street. In December so far, foreign institutional investors (FIIs) have net sold shares worth Rs 13,470 crore ($1.8 billion), according to provisional exchange data. That makes December 2021 a third straight month of outflows -- the first such instance since late 2016.
Why are FIIs selling?
This is due to a combination of measures by central banks like the US Federal Reserve, Bank of England etc to tighten liquidity, strengthening of the dollar, and rising inflation. So far, central banks had been pumping money into the system by purchasing bonds from commercial banks and financial institutions.
This helped keep interest rates low. As central banks reduce such bond purchases, there is less liquidity in the system, and interest rates are beginning to rise. This is prompting many investors to pull money out of risky assets like emerging markets and invest them in treasury bonds of developed markets.
Plus, inflation is bad news, because central banks respond by hiking interest rates. When interest rates rise, companies’ profits shrink. As a result, investors are no longer willing to pay high valuations and start pulling money out.
Are domestic inflows strong enough to offset this?
So far yes. In fact, if it weren’t for domestic flows, by now, the indices would have crashed to a 52-week low. That said, FII selling in heavyweight stocks can hurt sentiment and trigger a vicious cycle. Prices fall, causing more people to sell out, fearing a further decline.
Mutual funds have been net purchasers of Indian equities for much of 2021, with their net investments at Rs 1.9 lakh crore till November, AMFI data shows. In October and November alone, MF inflow totalled Rs 84,440.3 crore.
How does the strength of the rupee influence an FII’s decision to invest in Indian equities?
FIIs bring in dollars, convert those into rupees and buy Indian shares. They know that rupee is a depreciating asset, but are fine as long as equities deliver strong returns. Say, the value of the portfolio rises by 15 percent and the rupee weakens by 2 percent, that is not a problem. Remember, when FIIs want to take money out, they will have to convert rupees into dollars. A weak rupee means you will get fewer dollars. And it is a double whammy when you have a weak rupee as well as falling stock prices.
Which segments are FIIs particularly bearish on and which ones are they bullish on?
FIIs are bearish mostly on financial services stocks because of rising inflation. Nifty Bank has been among the worst-performing sectoral indices with a 13.9 percent decline year-to-date. FIIs are bullish on IT companies because they expect earnings growth to sustain. Also, since IT companies earn revenues in dollars, they benefit from a strong dollar.
How does India stack up against other emerging markets?
India has been among the best performing emerging markets in 2021 so far. By extension, that makes some of the underperforming emerging markets attractive relative to India at this point. Given the outperformance, some amount of profit-taking in Indian equities was inevitable, and should not be a cause of worry.
What can reverse this cycle of FII selling?
If the US Federal Reserve gets unnerved by the current bout of market volatility and says it won’t hike rates by as much as planned, it could provide a breather to equities.
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