comScore

Falling profits, strict Sebi rules could deter foreign investors

In FY22 and FY23 FPIs sold Indian equities worth  ₹1,40,010 crore and  ₹37,632 crore, respectively (Photo: AP)
In FY22 and FY23 FPIs sold Indian equities worth 1,40,010 crore and 37,632 crore, respectively (Photo: AP)

Summary

  • After two bleak years, FPIs are once again net buyers of Indian equities. But how long will the turnaround last?

Foreign portfolio investors have started investing in Indian stocks again after two lean fiscals. But there are fears that potentially stiffer disclosure norms and slowing profit growth could cause them to review their bullish stance.

In FY22 and FY23 FPIs sold equities worth 1,40,010 crore and 37,632 crore, respectively, but turned bullish in FY24 with 11,631 crore in net purchases in April, 43,838 crore in May, and 7,133 crore so far in June. Just nine weeks into FY24, FPIs have bought 62,602 crore net.

Data from the National Securities Depository Limited (NSDL) for May 2023 indicates that FPIs have focussed on sectors such as IT, fast-moving consumer goods (FMCGs), automobiles, auto components, metals and telecommunications. It also shows they reduced their exposure to the energy, textiles and power sectors.

By the end of May FPIs held around 48,79,628 crore in Indian equity assets. According to investment bank Goldman Sachs, more than half the firms in the NSE-500 index (which tracks the top 500 companies listed on the exchange) have delivered capital gains of more than 1,000% over the past decade. That’s an amazing record and explains why FPIs gravitate to India.

High historical returns aside, underlying reasons for the optimism include stronger-than-expected GDP growth and moderating inflation. The latest GDP estimates indicate the Indian economy may have grown at 7.2% in FY23, beating expectations. Consumer inflation in April 2023 eased to 4.7% from 5.66% in March, sparking hopes that the central bank will not raise interest rates again.

High-frequency indicators such as power consumption, railway traffic, and vehicle sales indicate there has been an increase in economic activity. India is very likely to lead the world in terms of growth this year. For FPIs with a mandate to invest in emerging markets, it is clearly the destination of choice.

There are, however, two possible areas of concern that could dampen their enthusiasm. One is that profit margins of Indian companies have dropped even though their revenues are up. A recent study indicated that the largest 1,000 listed companies saw their profits grow very little from over FY22 to FY23 thanks to higher energy costs, interest rates and employee-related expenses. Presumably, FPIs are betting this earnings slowdown is temporary. Indeed, energy costs are easing, as is generic inflation, including the prices of raw-material inputs such as industrial metals, plastics and semiconductors.

The second concern is regulatory. The capital-markets regulator, Sebi, recently released a consultation paper that outlines its intentions to impose stiff disclosure norms on certain categories of FPIs. In essence, if Sebi thinks an FPI is “high-risk" and it has more than 25,000 crore of exposure to Indian equity, or if a single corporate group accounts for more than 50% of its equity portfolio, the regulator will demand detailed information about its “beneficial" owners.

As things stand, an FPI may be controlled and funded by various opaque corporate entities that are themselves owned by unknown, opaque entities. That is, FPI ‘A’ may be controlled by company ‘B’ which is itself floated by company ‘C’ that is owned by company ‘D’. If A,B, C and D are all registered in jurisdictions like the Cayman Islands or Mauritius, the actual beneficial owners of these entities are unknown.

Sebi believes that certain Indian corporate groups may be using the FPI route to circumvent regulations about the minimum public float of a listed company. To take a company public in India, the promoters must sell a 25% stake in it at minimum. This is meant to prevent share price manipulation.

But the promoters or entities acting in concert with them could set up companies with opaque ownership structures abroad and funnel money via an FPI to buy a stake that actually belongs to the promoters. This would make it easier to manipulate stock prices and launder money.

Sebi also fears that FPIs are being used to circumvent its ‘Press Note 3’ (PN3). India has land borders with Pakistan, China, Bangladesh, Nepal, Myanmar, Afghanistan (via India’s claims on PoK), and Bhutan. PN3 is designed to prevent entities with connections to these nations from owning shares of Indian companies without explicit permission. Sebi has said the FPI route also could be used to circumvent this.

It will thus ask for detailed ownership information in cases where it classifies FPIs as high-risk. If the information is not forthcoming, the FPI will have to wind up operations within six months. Sebi itself estimates that only 2.6 lakh crore of foreign investments are potentially “high-risk". This represents about 6% of FPIs’ total equity assets under management and less than 1% of Indian companies’ total market capitalisation. But if the consultation paper turns into regulation, it could trigger some selling.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
more

topics

MINT SPECIALS

Switch to the Mint app for fast and personalized news - Get App