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Are foreign portfolio investors poised to make a spectacular return?

FPIs closed calendar year 2021 with an inflow of around  ₹26,000 crore, down a whopping 84% compared to 2020. (Photo: Mint)Premium
FPIs closed calendar year 2021 with an inflow of around 26,000 crore, down a whopping 84% compared to 2020. (Photo: Mint)

  • There may be short-term blips but India’s economic headwinds are tapering off
  • India’s economic environment is improving. Also, China may be losing its prime position in terms of FPI inflows—if there is any reduction in exposure to China, India stands to gain

NEW DELHI : Let’s take you back to 1 February, 2021. Industrialists, investors, traders, farmers, bankers and tax payers of all hues were probably glued to their television sets, listening to and analysing finance minister Nirmala Sitharaman’s every budget proposal. By the end of her speech, an hour and 50 minutes long, Indian investors let out a sigh of relief. It was a ‘no negative news’ budget.

The Sensex and Nifty marked their sharpest-ever budget rally in absolute terms, soaring 5% in a single day. But wait! Not everyone was that enthused. Foreign portfolio investors (FPIs) chose to buy only 1,500 crore worth of equities the same day after dumping over 4,600 crore in the previous trading session, data from the National Securities Depository Ltd shows.

This sort of a divergence—between how Indian stock markets and FPIs behave—is nearly becoming a pattern.

Decoupled
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Decoupled

Not too long ago, when Dalal Street was recovering from multi-year lows of March 2020, foreign investors were again dumping Indian shares. After a steep fall of over 23% in March 2020, the Sensex and Nifty recorded their best monthly gains of 2020 in April. As indices recovered 15%, the FPIs turned net sellers, to the tune of 6,884 crore during the month.

Enter calendar year 2021. FPIs closed the year with an inflow of around 26,000 crore, down a whopping 84% compared to 2020. That was the worst flows since 2018 when FPIs offloaded shares worth 32,628 crore. Lo and behold! The Sensex and Nifty rallied over 24%, the best gains in four years. All this makes one wonder: are FPIs really that crucial for the Indian stock market to perform well? FPIs were a driving force for domestic equities in the past, but not any longer, conclude market watchers.

“If FPIs are pumping in money, it may take the market even higher. But their absence today is not a sign of imminent collapse. Not only domestic institutional investors, high-net worth individuals and retail investors are also becoming a fairly powerful force to reckon with," said Ajit Mishra, vice president of Research at Religare Broking.

In fact, the FPI ownership in domestic equities, which was consistently above 20% since the fourth quarter of 2012-13, slipped to 18.4% as of 31 December 2021. Banks and IT services, the two most FPI-owned sectors, witnessed the highest FPI selling in the ongoing financial year.

While the FPI influence in the stock market may have been receding, the flow trend cannot be completely ignored. FPIs sold 38,521 crore between October and December 2021, but turned net buyers of equities as the new year began. So, are they back to the Indian shores?

Big questions

There are no easy or definite answers to the previous question. 2022 will have many variables and there are multiple scenarios.

The global financial environment is transforming, with central bankers shifting their focus on combating high inflation and laying the road map for normalization of monetary policies in the post-pandemic world. The US Fed first signalled three rate hikes of 25 basis points each beginning June 2022, but the minutes of its December meeting, released recently, hinted at rate hikes as early as March.

Brokerage firm Nomura points out that historically there has been a positive correlation between G4 (Germany, Japan, Brazil and India) central banks’ balance sheet expansion and FPI flows into India.

“The correlation has remained strong over the past two years of the pandemic when the G4 central banks’ balance sheet recorded an unprecedented expansion. In FY21, FII (foreign institutional investor) flows at $37.3 billion were the highest recorded in any fiscal year. With the pace of balance sheet expansion slowing, there has been a reversal of FII flows in the recent past," Nomura stated in a report released this month.

If the US Fed does dial back its bond buying programme aggressively in 2022, it will trigger fresh outflows from all emerging markets, including India. However, analysts such as Samir Arora, founder and fund manager at Helios Capital, remain optimistic.

“Despite all this easy money and abundant liquidity flushing around post covid-19, India didn’t get enough inflows on an absolute basis. The $3.8 billion inflow in 2021 was nothing for a country of India’s size although many other countries in the region had significant outflows. And still, India did well from a returns perspective," said Arora. “Since India and peer countries did not get big flows recently, there is hope that there will be no big outflows also, if at all."

Arora believes FPI inflows will be higher than what it was in 2021 as China is losing its prime position. “There is a lot of interest in India. The country was relatively preferred among emerging markets for the past few years, although the absolute amounts have not been very large (in public markets). If there is any reduction in exposure to China, its natural beneficiary will be India," Arora held.

India versus EM peers

Another concern looming large is India’s relatively higher valuation versus emerging market peers.

Global brokerage houses such as Goldman Sachs Morgan Stanley, Nomura and UBS had, towards the end of 2021, downgraded India mostly because of valuation concerns following a phenomenal rally in India compared to other emerging markets. India outperformed global markets such as Taiwan, Indonesia, Russia, Japan, China, and Korea in calendar year 2021.

The MSCI India Index, which measures the performance of the large and mid-cap segments of the Indian market, rallied 27% against a 5% fall in MSCI Emerging Markets Index during the same period, a Motilal Oswal Financial Services report stated. On valuation parameters, MSCI India quotes at a 99% premium to MSCI Emerging Markets, above its historical average of 59%. Besides, Nifty50 now trades at a 12-month forward P/E of 21 times, 9% above its historical average of 19.2 times.

That said, the valuation comfort lies in the eyes of the beholder. India’s valuation has not risen in an absolute but relative term.

“Indian markets are trading at a premium because the other markets have fallen a lot," said Arora. He stressed that Indian companies are much more capital efficient and therefore deserve much higher valuations. He cites the example of Taiwan Semiconductor Manufacturing Company (TSMC), a contract manufacturer of chips and the cynosure of all eyes because of the global semiconductor shortage.

“They are making record profits but have to invest much higher amounts in capital expenditure to get ready for new technologies and capacity. They made $6 billion in profits in the recent quarter (December 2021) but also announced $40+ billion capex for the year and $100 billion for next three years," pointed out Arora. “Indian software companies do not have to bet large amounts in capex or bet on future technologies anywhere near to this scale. Therefore, their valuations will always be higher."

The local factors

As many as seven states will vote to elect their assembly representatives this year. Uttar Pradesh and Punjab are the major states where elections would be held between February and March. How does a politically charged environment impact FPI flows?

A few brokerages expect populist measures in the upcoming Union budget—higher allocation to the Mahatma Gandhi National Rural Employment Guarantee scheme (MGNREGA), the PM-Kisan scheme, possible farm loan waivers, and some tax relief that pleases the middle class and those at the bottom of India’s economic pyramid. A populist budget beyond expectations or a loss for the Bharatiya Janata Party (BJP) in states where it currently rules, like Uttar Pradesh, may shock the market, triggering FPI outflows. However, this may only be a short blip.

“FPIs are long-term players. Political stability is always on their radar, but they are more concerned about macros, not so much about elections or how companies have performed in a quarter," said Ajit Mishra of Religare Broking.

Highlighting macros, Ashish Gumashta, CEO of Julius Baer India, said that short-term fluctuations aside, the country should continue to attract healthy inflows in 2022. “Some of the recent headwinds in the form of a sharp increase in energy and commodity prices (leading to a sharp increase in the Wholesale Price Index) seem to be gradually tapering off, while the economic environment continues to show improving trends as reflected in the various lead indicators and tax collections," he said.

Two sides of the same coin

Foreign investors, meanwhile, are closely tracking start-up activity in India. They have jumped on the bandwagon when it came to the primary market euphoria of 2021, replete with new-age public issues from companies such as Zomato, Cartrade, Nykaa, Policybazaar and Paytm. In fact, these investors pumped in $9.4 billion into the primary market thus far in 2021-22.

However, 2022-23 could be a different story. New IPO regulations by the Indian market regulator, the Securities and Exchange Board of India (Sebi), and the central banker’s lending restrictions on non-banking financial institutions for IPO financing are expected to massively bring down the oversubscription we have seen in the primary market, starting April 2022.

“These regulations have nothing to do with FPIs per se. But, if one side of the market is controlled, the other side behaves in a similar vein," said Arora.

Another important aspect: foreign investors are now equally interested in the private equity (PE) and the venture capital (VC) space. Even when the money doesn’t flow into the equity market, it is still chasing India, in a different asset.

“If enough inflows haven’t happened in 2022 in public equities, then where has the money gone? It has still come to India. The PE, VC investors investing in start-ups are the same end investors who come to the listed space," said Arora.

Eventually, PEs and VCs have to exit their private investments in the public market, or benchmark off public market valuations. Investors entering the PE space in itself suggests their long-term confidence in Indian financial markets, experts held.

Whatever happens in the FPI space, the message for the retail investor appears to be simple. They must track the quarterly movement of the FPI ownership for better understanding of how the market works.

According to brokerage HDFC Securities, the “key to spot potential gems" is to monitor FPI holding patterns in specific industries and companies. “It can give insights into the pockets of the Indian economy that they are bullish on". Citing a case study, the brokerage stated that between September 2018 and June 2020, FPI shareholding increased from 13% to 31% in Indian Energy Exchange (IEX), while the stock price provided a measly 15% return. The stock has surged nearly 350% between 2020 and now.

The brokerage expects a similar trend in stocks such as Mahindra & Mahindra, MRF, SBI Cards, IIFL Wealth, CreditAccess Grameen, Bandhan Bank, Aavas Financiers, ICICI Prudential Life and SBI Life.

The bottomline is that the FPIs are crucial market participants. The year 2022 may or may not see strong FPI inflows but studying their investment patterns, in individual stocks or sectors, will do retail investors a world of good.

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