FIIs to soon resume equity shopping

The interest of Foreign Institutional Investors (FIIs) has been one of the most critical factors driving the Indian markets. In fact, FIIs were solely responsible for the dizzying heights that the markets attained during the bull-run spanning from 2003 to the early part of 2008. Their participation can make or break the fortunes of the market. Worries of an FII pull-out have always spooked the market, while expectations of their participation have never failed to lend a positive bias.

After receiving record funds from FIIs in CY10, the first half of CY11 has turned out to be relatively low key. In CY10, the total FII inflows were around USD 30 billion. This was almost 30% of the cumulative flows since 1992. In comparison, the total inflow till June 2011 has been just USD 740 million, a fall of almost 70% from the same period last year. It has long been established that Indian equity markets are slave to FIIs inflow, and dance to their tune. An empirical study of funds flow and equity market performance also points towards the same thing. There has been a strong correlation between FII flows and the performance of the equity bellwether index, Sensex (see graph), CY10 being a notable aberration. The reason for such an exception was that, most of the flows went into new issues like Coal India, non-index companies and qualified institutional placements.

Nevertheless, the situation has been improving in the last few weeks, and India is on the FII radar once again. Until the time of going to press, the total net FII inflow was USD 2437.6 million. Has something changed in the last few weeks, leading to a reversal of the trend, or is it just an aberration? Can anything concrete be concluded from this? Before we answer this, let’s first understand the reasons why FIIs were shying away from the Indian equity market, and how those factors will play out in the second half of the year to impact FIIs inflows.

In truth, it is hard to point to any one factor that has led to such a lacklustre performance of the FIIs. We believe that a combination of a host of factors has led to such a slowdown. Tarun Anand, MD and Senior Officer, South Asia, Thomson Reuters, says, “Uncertainty in the US and European markets have contributed to FIIs preferring to sit on cash. With concerns of US credit rating downgrades, and volatility in international markets, FIIs are cautious in their own markets, and are hence not making aggressive investments in emerging markets at this stage”. However, it is not only international disorders that are containing the inflows; domestic factors are equally responsible for keeping FIIs at bay. According to David Gordon, Head of Research, Director, Global Macro Analysis, Eurasia Group, “Rising inflation and the move by the RBI to increase the interest rates to check inflation, combined with a slowing down of governmental reform programmes, has had a serious impact on FII inflow”. Therefore, it is evident that a combination of international factors as well as domestic factors is responsible for reducing FIIs.