Home / Markets / Mark To Market /  The  brouhaha  about India’s FPI flows

Indian stocks are flirting with all-time highs, but foreign portfolio investment (FPI) flows have been volatile in recent months. Over July-August, the market has seen net FPI outflows of around $1 billion, although August did see inflows.

Interestingly, this comes at a time the regulatory crackdown on China’s technology firms was expected to potentially benefit India. For emerging market equities, including India’s, which are high on covid-led stimulus, the flow of foreign funds remains paramount. It is more crucial now, given that the US Federal Reserve chairman Jerome Powell has indicated it could be appropriate to start reducing the pace of asset purchases this year. This, along with an accompanying rise in US Treasury yields, makes for a perfect storm that could drive dollars out from emerging markets, including India.

But experts are not too perturbed just yet. For one, the Fed’s ambiguity on the timeline of tapering has given equity markets enough ruse to continue their bingeing. Also, this time around, the Fed’s distinction between a rate hike and a reduction in asset purchases means that the advantage of low-cost funds for corporates is here to stay for some more time. After all, the cheaper cost of borrowing has played a key role in driving this market rally, irrespective of weak fundamentals. Second, the delta variant of the virus poses a threat and makes the recovery outlook a bit uncertain, even as the US economy is on the recovery path.

Aishvarya Dadheech, a fund manager at Ambit Asset Management, said, “Of course, tapering is a key concern, but a part of it is already factored in. We don’t see severe FPI outflows when the actual timeline is announced; India is better prepared now than it was in 2013."

To be sure, the outlook for primary market FPI inflows is upbeat, given that the initial public offerings (IPOs) of many firms and unicorns are lined up over the coming months.

What also offers comfort is that India’s external macros are relatively robust. “The current account is in surplus, forex reserves are close to all-time highs, and the rupee does not look overvalued. One consequence of this is that RBI will not rush to tighten monetary policy," said a report from Capital Economics on 25 August.

While India’s Q1FY22 GDP growth was marginally below forecasts, economists anticipate a faster revival in the coming days. High-frequency data for July and August showed recovery is gathering pace. Sure, the big risk to growth ahead is the potential third wave that could hit the country.

For now, these factors, along with the improving covid scenario, the increasing pace of vaccinations and expectations of solid economic and earnings recovery ahead, augur well for Indian equities. So far this calendar year, the Nifty 50 index has surged as much as 24%. According to Dadheech, “DII money in equities is here to stay, given the lack of investment alternatives."

Nevertheless, India’s valuations are pricey. In a report on 3 September, analysts at Jefferies India Pvt. Ltd said, “Nifty’s premium over EM and AxJ (Asia, excluding Japan) index has risen to near the all-time high of 68%/50% as compared to the average of 37% and 25%, respectively. We also find that our favoured valuation gauge of yield gap (1/PE less 10-yr G Sec yields) has spiked to a high of 165 basis points (bps) as against the long-term average of 95bps." One basis point is one-hundredth of a percentage point.

While some analysts maintain that valuations of the Indian market are likely to remain expensive, others are cautious. True, expensive valuations and the looming threat of tapering means the risks are high for equities. Moreover, the delayed and lack of meaningful recovery in corporate earnings could also sour investor sentiment in the medium term. It is worth noting that earnings upgrades for this financial year (FY22) and the next were meagre after the June quarter results. To justify such rich valuations, earnings have to make a solid comeback.

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