Indian stock market which remained one of the favourite hot spots for foreign institutional investors (FIIs) is gradually losing its shine. The market is ceding ground to its neighbour and India’s only competitor not only in Asia but world over among emerging economies i.e., China. Overseas investors have increased portfolio weightage on China among emerging market allocations which has resulted in slow flow of funds into the Indian market. This article details the problems of Indian economy vis-à-vis the opportunities offered by Chinese market which compelled the strong movement of fund flow across two largest economies of Asia.
As far as the FII flows into India are concerned, the flow seems to have taken low tide route. FIIs in 2015 (As of 22nd May 2015) have sold Rs 66,504 Crore worth of equity against Rs 61,350 Crore of purchases. Further, the FIIs have remained the net seller in the stock market except few instances like FIIs buyout of Daiichi Sankyo’s stake in Sun Pharmaceuticals Ltd in April (See chart below).
Growth in net purchases/sales
Over allocation of FII portfolio to India has compelled the investors re-look their portfolio. In the past, FIIs seemed to have over looked the weak growth of emerging marketing (including India) due to the expectation that the new Narendra Modi led NDA government at the centre will be quick in rebounding corporate earnings. Other reasons which resulted in over allocation to emerging economies have been the expectation of falling global commodity prices and the earnings boost up it would bring. No other market except emerging markets offered strong opportunity as inflation was on declining trajectory while growth was starting to pick up. Amidst this, India was strategically considered to be one of the few growth spots as the investors finally deconstructed that India is different from China and other emerging economies and has its own nuances and factors which drive its performance.
However, the trend didn’t last for long and gradually FIIs started pulling out funds from the Indian market. One of the primary reasons for FIIs shifting focus has been the weak corporate earnings season. Some of the other reasons such as strong rebound in crude oil prices coupled with slow implementation of reforms at the Central level, along with weakening rupee against dollar did the damage thereby forcing FIIs pulling out huge chunk of funds.
Amidst this development, FIIs are now looking at China as an alternative investment destination. It is expected the trend will continue as China remains one of the most favoured markets among the lot of emerging markets (all thanks to its super manufacturing capabilities). One of the major reasons for such behaviour has been that the Chinese stocks have outperformed in last few months. Their cheaper valuations have made them lucrative enough to attract investors. Further, regulators in China have also supported the investors by introducing a scheme which allows foreigners to buy China’s mainland ‘A’ shares though the Hong Kong stock exchange and vice-versa. Further, the back to back rate cut from the Chinese Central Bank not only surprised the market but did the needful in attracting funds.
(In the past the Chinese index has doubled as China’s central bank has cut interest rates twice since November 2014. It is expected that the government will ease policy further in order to meet the growth target of 7 per cent. This indicates that the market has growth opportunities going forward and we can see an upside in the index over the next 1 year period. The market doubled in the past as it witnessed traders borrowing money for investment in shares and also new investors entering stock market at an unprecedented pace. It is seen that Chinese market (historically) has seen bull market every 6-7 years in a cyclical manner post which bear phase is witnessed when majority retail investors stay away from the market.)
Further, the MAT (minimum alternate tax) issue added fuel to the fire where the Finance minister took an important step by clarifying that w.e.f April 1, 2015, MAT will not be applicable to FIIs. This indicates that FIIs have to resolve the issues of the past years.
Factors impacting FII
- Risk- When risk in a market increases, the foreign investors pull out money thereby creating deficiency of funds
- Inflation- High inflation results in declining returns on fixed income instruments like bonds and fixed deposits.
- Interest rates- Interest rate is one of the key factor which determines how a business would perform. For a business, cost of borrowing rises with interest rate change thereby impacting the profitability of the company. This also results in delaying any investment activity which may be funded by borrowing funds. A low interest rate attracts more funds in an economy from foreign investors.
- Political instability- If any news which impacts the nation in a negative way results in FIIs pulling out of the market. On the other hand, if there is any good news, returns increases thereby attracting FIIs.
- Equity Returns- This is the main driving force for FIIs. Any increase in return in the target market vis-à-vis home market of FIIs will attract more funds.