Mumbai: The number of investors registered as foreign institutional investors (FIIs) has dropped so far this year after peaking in November, coinciding with the fall in share prices. This, of course, doesn’t necessarily mean that this class of investors is fleeing India. The growing use of alternative investment routes such as index funds and the costs of compliance involved in registering an FII account could limit the number of foreign funds, analysts say.
The number of FIIs registered peaked at 1,741 in November and has fallen to 1,707 in March. During this period, the country’s bellwether equity index, the Sensex, has fallen 14.3% from its lifetime peak of 21,005.
Also See | (Graphic)
A spate of negative news flow relating to corruption, concerns over inflation, rising interest rates and high crude oil prices has led to an FII outflow of $1.91 billion (Rs8,595 crore today) so far this year.
Foreign investors had pumped in a record $29 billion of net investments in 2010, making India the best performer among the top 10 markets of the world.
“Flows have been negative over the past few months with FIIs investing money away from India,” said Nick Paulson-Ellis, country head for India at Portuguese investment bank, Espirito Santo Securities. “So it is not surprising to see the number of registrations come down.”
However, analysts say that many large investors would have registered over the years while others might be using alternative ways of investing in India. Most foreign funds would have obtained their licences to operate in India and, hence, the growth in the number of FIIs may have peaked, said Paulson-Ellis.
Data from Securities and Exchange Board of India (Sebi) shows that the number of FIIs registered in India nearly tripled between 2004 and 2010, and has slightly declined since then. A steady interest in the Indian economy, which has been growing at an average rate of 8.5% over the past five years, attracted new investors to open accounts in the country. Remarkably, the number of new FIIs rose consistently, even after the market crash of 2008, and started moderating only in 2010.
Stricter regulatory norms on participatory notes (PNs) and faster registration for FIIs by the capital market regulator contributed to this surge.
PNs are derivative instruments that allow unregistered foreign entities to invest in India through existing FIIs, or their sub-accounts in India. PNs, which accounted for a majority of FII investments in 2007, contribute only 12% of such portfolio inflows now, according to data from Sebi.
According to the Sebi website, as of 5 December, 71 FIIs had withdrawn or surrendered their registrations as they could not comply with certain stringent disclosure norms mandated by the market regulator in April. Sebi had asked FIIs to comply by 30 September and said all non-compliant FIIs could not initiate fresh positions. It had issued a list of 179 FIIs on 5 December that were not compliant with the new rules. Of these, Sebi said, 71 FII accounts “are surrendered/applied for surrendered/expired”.
While the popularity of PNs has fallen, the growth in exchange-traded funds (ETFs) and index-based derivatives in overseas bourses have given new investors an easier way to invest in India, pointed out Ullal Ravindra Bhat, managing director of the Indian arm of Dalton Strategic Partnership Llp, a global fund registered as an FII in India.
Flows through ETFs rose 35% to $4.1 billion in 2010 over the previous year and accounted for 15% of the net investments in Indian equities made by foreign investors, according to data from Credit Suisse AG.
Ramit Bhasin, head of global markets at the Indian arm of Royal Bank of Scotland Plc, said one should not read too much into the decline in number of FIIs as long as the quantum of investments remained strong. “While the number of new investors moderated in 2010, flows touched a record high,” said Bhasin.
This year, the consensus among analysts is that inflows might continue to be weak in the first half of the year, while an improved macro outlook on India and a reversal of flows from developed to emerging markets could benefit the country in the second half of this year. Still, not everyone believes that it would be possible to surpass the record $29 billion investments in Indian markets by FIIs in 2010.
“Globally we may be moving to a different regime, with higher interest rates in the developed world and rising risk aversion, which would lead to a moderation of flows to emerging markets, including India, over the next few years,” said Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd.
Low bond yields and easy liquidity helped emerging markets rally over the past two decades, but things might turn out to be different going ahead, with rising yields on government bonds because of higher debt-GDP ratio and rise in interest rates as Western economies seek to raise their savings rates.
“The record flows we saw in 2010 might remain the watermark for a long time to come,” said Mukherjea.
N. Sundaresha Subramanian also contributed to this story.
Graphic by Sandeep Bhatnagar/Mint