Is foreign investor interest in India likely to wane?

India has attracted the maximum amount of foreign institutional inflows among countries in the Asia Pacific region so far this year. But a number of factors suggest that foreign inflows may not be quite so robust in the near future.

The purchase of local stocks by foreign institutional investors (FIIs) has fallen in the past month. Net inflows have totalled about $700 million so far in August compared with fund injections of close to $2 billion in each of the previous two months.

India is no longer among the most loved countries for global emerging market investors, said this month’s Bank of America Merrill Lynch fund manager survey. Investors have moved from “overweight” on India in July to “underweight” in August, indicating that they think the market is overbought. China is the new favourite as its June quarter economic growth beat forecasts.

The change in FII appetite for Indian stocks could be due to a couple of factors. One, local equity valuations have rocketed in the past three months. MSCI India’s price-earnings multiple is at a 40% premium over that of MSCI Emerging Markets index.

Two, global fund managers are quite close to their highest fund weight for India over the past five years. A quick look at the 30 Sensex firms shows that FII holdings at the end of June comprised 22.5% of their market cap, an all-time high.

That said, until there is an interest rate hike in the US there will a surplus of liquidity sloshing around global equity markets. There is a good likelihood that some of this will find its way into emerging markets. Already, investors are warming up to this category owing to the lack of other options. European growth has spluttered to a standstill.

The Bank of America fund manager survey mentioned above said that a net 17% of global investors are overweight on emerging market equities, the highest in 17 months. But it’s also important to know that emerging market stocks as a category are under-owned relative to history.

Therefore, fund flows could continue to emerging markets. Some spillover will continue to be seen in India as well—even if it is no longer a favourite.