The National Stock Exchange’s Nifty index has tested lows of about 4,500 on two occasions in the past three months—last week and around mid-March. Foreign institutional investors (FIIs) have behaved in a strikingly different fashion on the two occasions. In March, they found valuations low enough to pump up purchases. In just eight trading sessions between 18 March and 31 March, they were net buyers of stock worth Rs2,404 crore in the cash segment and took net long positions worth Rs3,838 crore in the futures segment, data published by market regulator Securities and Exchange Board of India (Sebi) show.
The Nifty has traded at pretty much the same level this month, but FIIs have net sellers of stocks worth Rs6,770 crore in the cash segment and have taken net short positions worth another Rs2,010 crore in the futures segment in the first 10 trading sessions of this month. That amounts to average daily net sales of Rs880 crore in both segments, a stark contrast to average net purchases of Rs780 crore in mid- to late-March.
What gives? Between 18 March and 31 March, when the large purchases were made, the currency exchange rate hovered around Rs40 to a dollar. Few people expected the rupee to depreciate sharply then. In fact, for even much of April, the exchange rate was around 40 and FIIs took net long positions worth Rs3,834 crore in both the cash and futures segments. The sharp depreciation in the rupee since May, however, seemed to have caused a change in strategy. In May, they were net sellers of Rs9,296 crore in both segments.
An appreciation in the rupee enhances returns for FIIs in dollar terms while depreciation does the reverse.?And, in what’s working like an almost vicious cycle, mounting FII outflows are further hurting the rupee. Also, high oil prices are resulting in high trade deficit, which foreign investors are generally not comfortable about.
FIIs seem to be constrained by outflows in funds tracking the country and the region as well. Funds tracked by research firm EPFR Global have seen outflows in each of the Asia-Pacific markets in the week till 11 June. On the other hand, these funds saw strong inflows in the late March and early April. Last week’s outflows in Asia ex-Japan funds were the worst since January, while inflows in early April were at a 19-week high.
It’s interesting that the Nifty pretty much held its low of about 4,500 (it fell to 4,449 this month) despite the heavy selling by FIIs.
Data published by the Bombay Stock Exchange show that domestic financial institutions have been net buyers of stocks worth Rs4,500 crore in the first 10 trading sessions of this month. Less than one-third of that came from mutual funds, Sebi data show, which means the majority of the buying is from insurance companies. This segment has repeatedly come to the rescue of the market in the past two years, thanks to regular flows from investors locked in through unit-linked plans. But it’s doubtful these investors would continue to lend support if FII outflows continue at the same pace.
The return of regulatory risk
Focused as we are with the weakness in the markets, not many are paying attention to the progress of reforms. While few people had any hopes of reforms under the current government, most of us have not realized how we have actually gone back on many reforms.
Credit Suisse has recently brought out a research note, India Strategy: Re-regulation times, which points out that re-regulation is the new trend. Here are some of the examples of the backsliding on reforms given by the note: While under-recoveries were zero in 2002-04, they are very high now; non-urea fertilizer was de-regulated in the early 1990s, but is back under price control; ad hoc trade bans and duty increases are once again in vogue; the cash reserve ratio was banished as an inefficient tool of monetary policy in the 1990s, but it’s back with a vengeance now; the government has started to interfere in fixing interest rates; loan waivers have returned after a decade; and direct price controls are back.
Credit Suisse estimates that the Central government’s fiscal deficit for fiscal 2009 is likely to be around 7% of gross domestic product after taking the impact of off-balance sheet items such as oil bonds and also after allowing for the pay commission and farm loan waiver.
But are reforms important? After all, the markets did very well in 2004-07 even without reforms. Credit Suisse believes that, since India is dependent on the world to attract growth, the backsliding on reforms will hurt investor sentiment and, hence, the markets.
They point out that while credit growth has been slowing for several quarters, overall growth has been accelerating, which they say is proof that growth has been financed with equity. With the market for initial public offerings in the doldrums, growth is likely to be hit.
Also, the note says Credit Suisse expects downward revisions in earnings of 10-15%, with real estate and financials taking the biggest hits. The lowest downgrades of between 3% and 5% will be in the defensive staples, health care, utilities and telecom sectors. Unsurprisingly, with earnings downgrades on one hand and higher risk premium on the other, the brokerage sees the year-end Sensex at around 13,000. Also unsurprisingly, they are “severely underweight” anything owned by the government.
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