FII fund flows set to top 2007 levels

FII fund flows set to top 2007 levels

Mumbai: The year 2009 began with a whimper but has ended with a bang, at least as far as portfolio investments by foreign institutional investors, or FIIs, into the Indian stock market go.

Foreign money moves markets in India, and the huge FII inflows after March inevitably helped equity prices bounce back from their panic-stricken lows. FIIs have already pumped in $17.13 billion (around Rs80,000 crore) till 24 December and they are on course to surpass the levels seen in 2007, at the height of the bull market. This gush of money in 2009 comes after FIIs sucked out $12.18 billion in 2008 by selling Indian shares, the most in 15 years, in the aftermath of the global financial meltdown after the collapse of investment bank Lehman Brothers Holdings Inc. FIIs continued to head for exits in January and February as well.

Also See Increasing Foreign Funds (Graphics)

Market experts expect strong inflows to continue in 2010, as the Indian economy outperforms most other national economies. The huge capital needs of Indian companies as they try to repair balance sheets and fund capacity additions with money raised from share sales are also expected to act as magnets for foreign equity investors.

“India has recovered faster than other emerging markets. As long as the Western economies do not call for an exit from the stimuli packages and the pressure on the local currency is kept under control, there will not be any significant change in FII inflows during 2010," said Ullal Ravindra Bhat, managing director of the Indian arm of Dalton Strategic Partnership Llp, a global fund registered as an FII in India.

FIIs have invested at least $72.39 billion in India since 1993, when the government opened the doors to foreign portfolio capital.

However, foreign investors may be a bit watchful in the first quarter of 2010 as they figure out how soon the government and the Reserve Bank of India will withdraw the accommodative policies put in place to keep growth on track during the global economic collapse at the end of 2008. A growth revival and renewed inflation make tighter monetary and fiscal policies very likely in 2010.

According to a report by Deutsche Bank AG, India Outlook 2010, “…Wholesale Price Index inflation could readily exceed 7% by the second quarter. So far the central bank has refrained from tightening monetary policy as the economic recovery has been at a nascent stage, but we expect liquidity tightening measures from January onward and rate hikes from April onward."

A report by Citigroup Global Markets cautions against two polar risks. “A bout of risk aversion triggered by negative global events could lead to a fast reversal of such flows and is the key risk to our positive stance... Conversely, a strong positive catalyst could attract large inflows, which can trigger a liquidity-driven rally and take markets into an overvaluation zone."

Even as the existing FIIs stepped up investments into India, new players came to sniff out opportunities in 2009, which saw 110 new FII registrations and 432 new FII sub-accounts.

“Money will chase growth. The FIIs are confident about domestic growth and the abundant liquidity for money market instruments. Also, a lot of this FII money will be absorbed by IPOs and QIPs during the coming year," added Bhat. IPOs are initial public offers and QIPs are qualified institutional placements.

The good times may roll on, but there is an important difference in the way FII money has come into India in 2007 and 2009—a difference that may offer some clues about 2010. While a majority of FII inflows came via participatory notes, or PNs, till 2007, fund managers have opted for the sub-account route in 2009.

Till 2007, FIIs were mostly using the PNs, derivatives used by foreign funds not registered in India to trade local shares while the actual investors remained anonymous. Capital market regulator Securities and Exchange Board of India (Sebi) had banned PNs in October 2007, amid concerns that volatile foreign exchange inflows were fuelling an asset bubble.

A year later, the credit freeze forced the regulator to lift the ban as part of its efforts to keep capital within India.

But foreign investors now prefer to park their funds through the sub-account route as there is an uncertainty whether Sebi will continue to allow FIIs to issue PNs or not.

A sub-account, an actively managed investment book, is run in the name of registered FIIs, but managed by separate fund managers.

From the peak of 55.7% in June 2007, PNs now account for 16.5% of total assets managed by FIIs in October 2009. This proportion has remained almost constant since January, despite the surge in FII inflows.

Meanwhile, according to a report by Citigroup Global Markets, a combination of external factors such as global liquidity, a weak dollar and higher risk appetite coupled with the domestic story of higher growth and interest rates sets the environment for a continuation of dollar inflows in 2010.

Graphic by Ahmed Raza Khan/Mint