Foreign institutional investments have seen net outflows of ₹ 14,212 crore so far in the current fiscal year, the highest in the last seven fiscal years (see chart).
Foreign institutional investors (FIIs) are withdrawing money from India as they reduce exposure to emerging markets because of the commodity slump, while companies’ earnings continue to disappoint and the reform momentum remains slow.
What is surprising, however, is that the benchmark Sensex has fallen 7.7% in FY16 so far despite record domestic institutional investor (DII) flows of ₹ 60,368 crore. This is because even though DIIs are buying in large quantities, buyers are coming in only at lower levels. The sellers—mainly FIIs—are more aggressive.
“DIIs are aware that the market is going to fall further; hence they are putting in buy orders at lower levels," said U.R. Bhat, managing director of Dalton Capital Advisors (India) Pvt. Ltd. The market generally shifts in the direction of who is more aggressive, buyers or sellers, he added.
Note that in FY12, even though FIIs bought shares worth ₹ 45,035 crore, domestic investors led by insurance companies were aggressive sellers, leading to a 10.5% slide in the Sensex (see chart).
Moreover, although India remains a favourite among emerging market investors, with many of them overweight on India, they may be recalibrating their positions. For instance, while CLSA continues to remain overweight on India, in its November strategy note, the Hong Kong-based brokerage firm said, “Admittedly, the (Narendra) Modi government either underestimated the complexity of its economic inheritance or overestimated its ability to fix the problems quickly. There has been a healthy reset of the unrealistically high expectations but investors still hoping for big-bang reforms are bound to be disappointed."
Also, the Bihar election verdict is negative for Indian equities in terms of sentiment in the near term, according to market analysts. It will make it difficult for the National Democratic Alliance to strengthen its position in the Upper House and may also create a gridlock for passage of important bills on goods and services tax and land acquisition.
Additionally, there is no recovery seen in corporate earnings. Following the September quarter earnings announcements, brokerage firms have resumed cutting earnings estimates for Sensex and Nifty companies.
In a note dated 16 November, Bank of America Merrill Lynch said, “We have witnessed a sharp downgrade in FY16 Sensex EPS (earnings per share) growth from 16.5% to 12.5%. We expect further downgrades for FY16 consensus Sensex EPS growth to 8%-9%. FY17 Sensex EPS growth has largely remained stable near 22% which we believe is optimistic and could also see significant downgrades." Kotak Institutional Equities on 16 November slashed its earnings estimate, saying, “We now project the FY16 and FY17 net profits of the Nifty-50 Index to grow 8% and 20% versus 14% and 19% at the start of the 2Q FY16 results season." There could be another two-three quarters of earnings estimate cuts until the economy gathers momentum. Rich valuations may keep the market subdued for some more time, according to Kotak.
Another big worry for the Indian market is a potential interest rate hike by the US Federal Reserve. Because of the commodity slump and a potential US rate hike, the emerging market basket is not preferred by foreign investors as money may flow back into US government bonds.
While India may continue to see a big allocation in the emerging market basket because of a relatively favourable macro environment, it might see lower inflows because the overall pie is shrinking. “Emerging market flows to India may not be as strong as earlier, but Asia-Pacific flows and global flows to India may continue," according to Gautam Chhaochharia, head of research at UBS Securities India Pvt. Ltd.
Clearly, the outlook for FII inflows is clouded, unless economic growth surprises and the reforms gather momentum.