Explained: What FPIs’ market exit means

The continued capital outflows from the capital markets have upset equity markets and led to a weakening of the rupee against a background of rising inflation worldwide. With the US Federal Reserve planning to raise interest rates further, outflows are likely to continue, putting pressure on the Indian currency.

Why is capital flowing out?

Foreign portfolio investors (FPIs), holding about 19.5% of the market capitalization, have pulled out Rs 42,000 crore so far in June, bringing total outflows to Rs 260,000 crore ($33 billion) since October 2021. attributed to the tightening of monetary policy by the US Fed, which has gone through a rate hike to keep inflation in check. Other central banks, including in Great Britain and the Eurozone, are following suit.

“Relatively high valuations in India, rising US bond yields, a rising dollar and concerns about the possibility of a US recession caused by aggressive tightening are factors behind the pullback in FPIs,” said VK Vijayakumar, Chief Investment Strategist at Geojit Financial services.

When the global economy took a hit, central banks around the world cut interest rates and announced liberal monetary policies. While this helped the economies recover and led to higher consumption, the excess liquidity in the financial system led to inflation. This is why central banks have started tightening monetary policy and raising interest rates. In India inflation rose to an eight-year high of 7.79% in April, prompting the RBI to raise the repo rate by 90 basis points to 4.90%.

How will this affect the markets and the rupee?

The pullback is dampening sentiment in the stock and forex markets. The benchmark Sensex is down 16% from its October 2021 high of 62,245.43 to 52,266.72 on June 23. The impact of FPI sales on the markets is visible, with volatility increasing and share prices falling. While these sales by foreign investors have so far been largely absorbed by domestic investors led by domestic institutional investors (DIIs), the flow of funds from private investors and domestic institutions has slowed of late. Between November 2021 and June 2022, DIIs netted Rs 2.84,488 crore (over $37 billion) in Indian equities, providing a counterbalance. However, experts say retail flow and DII inflows are now weakening, and markets could weaken further if FPI outflows continue.

India’s foreign exchange reserves have fallen $46 billion in the past nine months to $596.45 billion on June 10, 2022, mainly due to the appreciation of the dollar and the inclusion of FPIs. The rupee has fallen 7.3% to an all-time low of 78.30/32 against the dollar. Rupee depreciation is never good for the overall stock market, and the withdrawal of foreign investors can lead to a decline in stocks and investment in equity funds. Foreign investors generally stay away when the currency falls and interest rates rise in the US and developed markets.

Analysts said a lower rupee against the dollar is keeping import bills higher, pushing inflation even higher than it is now. Higher inflation is detrimental to the overall market. If the rupee does not gain strength, the outflow of FPI will continue, which is also a negative point. A strong dollar is good for export-oriented companies, but bad for import-oriented industries such as oil, gas and chemicals. With the dip in the rupee, oil imports and other imported components will become more expensive, further leading to higher inflation. Travelers and students studying abroad will have to spend more rupees to buy dollars from banks. People are directly affected by the decline of the rupee as fuel prices skyrocket.

FPI outflow in 2022

How do FPIs work?

In times of global uncertainty, foreign investors embrace risky trade, meaning they take money out of risky assets like stocks and add more bonds and gold. When interest rates in the US and other advanced economies rise, they raise money from emerging markets such as India and invest in the bonds in their home markets. The 10-year US bond has skyrocketed from a low of 0.54% in July 2020 to over 3.30% today.

“The global investment scenario has been plagued by risk-free trading since October 2021, as central bankers hinted at a policy tightening, with inflation changing from ‘temporary’ in nature to somewhat of a headache in the medium term. This helped global bond trading as yields began to become attractive, prompting investors to allocate a larger share to fixed income as an asset class,” said a report from Axis Mutual Fund. The rise in global yields is not good news for Indian stocks and investors. The sell-off of the FPI has led to a fall in the valuation of top 500 companies, with some losing 15-20% in the past 9 months.

How big are they in India?

FPIs are the largest non-promoter shareholders in the Indian market and their investment decisions have a huge impact on stock prices and the general direction of the market. Holdings of FPIs (by value) in NSE-listed companies amounted to Rs 51.99 lakh crore as of March 31, 2022, down 3.36% from Rs 53.80 lakh crore as of December 31, 2021, due to the ongoing sell-off since October 2021.

FPIs have significant stakes in private banks, technology companies and large corporations such as Reliance Industries. The US accounts for much of the FPI investment at Rs 17.57 lakh crore as of May 2022, followed by Mauritius Rs 5.24 lakh crore, Singapore Rs 4.25 lakh crore and Luxembourg Rs 3.58 lakh crore, according to data available from the National Securities Depository Ltd (NSDL).

Will the rupee fall further?

The rupee has continued to depreciate above general expectations of a gradual weakening, despite the RBI selling dollars from its forex cat to stabilize the currency. At the current spot dollar and rupee levels, the year-end forward price has risen above the projection of 79 per dollar by the end of 2022, according to a report from the Bank of America Securities. “We believe that risks are still skewed towards more depreciation of the rupee as the fundamental outlook has deteriorated further, mainly due to higher oil and other commodities. We have raised our projection from 79 currently to 81 per dollar by the end of 2022. However, we see the RBI’s strong reserves as a mitigating factor against tail risk,” it said.

The rise in US inflation, concerns about interest rate hikes and the fall in the stock market are weighing on the rupee’s sentiment. On the other hand, more Fed rate hikes will lead to higher outflows from foreign portfolio investors.

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What should investors do?

If FPIs continue the outflows and there is a dip in retail and DII participation, as market participants have noted in the recent past, equity markets could face a further correction. While other markets may correct further than current levels, experts say investors should stick with their existing investments in domestic equities.

“Even if the weakness in the markets is likely to continue, investors should not look forward to buying back their positions in the current market. They should stay with them because a rebound in economic activity, which is imminent and could gain momentum in the next one to two years, would result in a rebound in the markets going forward and thus gains for investors.” said the CIO with an asset manager. He went on to say that investors should not go for lump sum investments and instead should continue with the systematic investment plan mode.

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