Mumbai: Even though net fund flow from foreign institutional investors (FII) into the Indian market reduced by 10% in 2006, their trading activity nearly doubled, indicating increased presence of foreign speculative money through hedge funds and promissory notes.
According to the Economic Survey, FIIs have been doubling their gross turnover— total of all buy and sell orders including equity, derivatives and debt—in Indian capital markets every year from 2004.
The gross turnover of FIIs stood at Rs20.62 lakh crore in 2006 against Rs10.5 lakh crore in 2005 and Rs5.27 lakh crore in 2004.
The net FII inflow, which is the difference between all buy and sell transactions, was Rs41,294 crore in 2006, Rs46,111 crore in 2005 and Rs40,120 crore in 2004. In other words, FIIs traded 50 times the fund they invested in 2006 compared with 23 times in 2005 and 13 times in 2004.
The high turnover, many believe, has to do with the entry of foreign hedge funds, which buys and sells securities fast to take advantage of arbitrage opportunities.
“A lot of FII turnover is on account of derivatives, arbitrage and participatory notes,” says Rajiv Thakker, director and senior vice-president of research at the institutional brokerage Parag Parikh.
The total number of FIIs registered with the Indian capital market regulator increased by 27% to 1,044 in 2006, while the number of FII sub-accounts, through which many hedge funds and entities trading in participatory notes enter Indian stock market, increased by 34% to 3,045 in 2006.
FII share in the total turnover in Indian markets, though growing fast, is still only 10.4%—Rs20.6 lakh crore—in 2006 as against Rs198.6 lakh crore for the whole of Indian market. Against the net fund inflow of Rs41,294 crore by FIIs, Indian mutual funds increased the funds under their management by Rs1.24 lakh crore in 2006.
However, this is not indicative of fresh fund flow into the kitty of domestic mutual funds as the figure takes into account the impact of price rise in securities in which they have invested. For instance, if a fund house’s Rs1,000 crore worth investment in various stocks appreciates by 40%, the fund under management will rise to Rs1,400 crore even without any fresh funds flowing. Sensex, the benchmark index, has appreciated about 40% in 2006.
The Survey expects FIIs to play a more significant role in the next financial year, 2007-08. The continued growth in global and Indian economy “is expected to sustain the interest of not only the domestic investors but also scale-up FII interest in Indian equity and debt papers and to retain India as one of the preferred destinations for portfolio investment,” it says.
Indian stock markets continue to be one of the most expensive emerging markets. The BSE Sensex was trading at a price-to-earnings multiple of 22.76 or that many times the earnings of the underlying shares, and S&P CNX Nifty was at 21.26 as of end-December. Compared with this, the Thailand SET was trading at 9.40, Malaysia KLCI at 17.35, South Korea KOSPI at 12.21 and Taiwan TWSE at 20.85. Only Indonesia JCI with a price-earning multiple of 25.10 times trades at a higher valuation. “The better valuation could be on account of the good fundamentals and expected growth in earnings of Indian corporates,” the Survey says.
In terms of the ratio of market capitalization as a percentage of gross domestic product (GDP), Indian markets compare well with other emerging markets.
This ratio indicates the relative size of the capital market, besides investors’ confidence and future earning potential of Indian corporates. Market capitalization of the National Stock Exchange, at $834 billion, is 91.5% of GDP.
In comparison, it is 33.3% of Chinese GDP, 96% of Japanese GDP, 94.1% of South Korean and 133.8% of the GDP of the US.
The combined market capitalization of NSE and Bombay Stock Exchange had crossed the country’s nearly $800-billion GDP when the sensitive index crossed the 14,000 mark.