FPI Saviour or Destroyer?

FPI Saviour or Destroyer?

At a time when the market observers had started to believe that Indian markets can survive an onslaught of foreign portfolio investments (FPIs) owing to steady inflows from domestic investors, the recent violent correction highlights how dependant Indian equity markets are on FPI investment flow. Yogesh Supekar and Anthony Fernandes highlight why and how FPIs are crucial for the Indian equity markets.  

There are many ways an investor evaluates a quality stock. Some track the PE ratio or the valuations while a few observe technical trends before making an investment decision. Says long-time investor Rahul Gaikwad who follows fundamental analysis to identify quality stocks: “One of the most significant factors before buying any stock for me is FPI ownership. FPI investment in the stock means the stock is attractive in the eyes of global investors and that is good enough for me to invest my funds. Of course I do my own fundamental analysis but FPI ownership seals the deal for me.”

“FPI ownership and extremely high interest in HDFC’s group stock is just an example. I am bullish on the pack as FPIs almost always keep on buying these shares,” he adds. This indicates the clout FPIs have on the minds of investors. If an investor gets a hint that the foreign portfolio investors are going to increase stakes in a particular stock, he or she may seriously consider quickly buying shares of that company – fundamental analysis becomes secondary. What are these FPIs and why are they respected at all times? Should investors track FPIs? Are FPIs good for the Indian equity markets or they should be banned in a phased manner? Does FPI indicate clean money or otherwise?

Defining FPIs

FPIs are essentially corporate bodies, broad-based funds, foreign individuals or pension funds that are registered outside India but want to participate in the Indian equity markets.

Size of FPIs
All FPIs put together own roughly half of the free float market capitalisation in India. If we consider the fact that the total market capitalisation of the Indian equity markets is roughly Rs 112 lakh crore and half of it is owned by the promoters, it leaves us with approximately Rs 56 lakh crore as free float market capitalisation. Half of this free float market capitalisation is owned by all the FPIs put together, which comes to around Rs 27 to 28 lakh crore. Note that market capitalisation keeps changing each day as the stock prices change daily. Imagine a single investor category that owns that large pie of the Indian equity! Is it huge?

Definitely, it is huge; in fact, it is more than huge if we consider the fact that very many companies that are listed on bourses are MNCs, i.e. their promoters are not Indians, as for example, Nestle, HUL, Astra Zeneca, etc. FPIs have grown over the years in India. India first opened up its markets for FPIs, previously known as FIIs, in the year 1992. Now, knowing that FPIs are mammoth players in the Indian equity market, the million dollar question is whether they are detrimental for the Indian markets or do they pose huge risks for Indian markets? In other words, can they trigger huge market falls which can’t be absorbed by domestic investors? 

Market Correction and FPIs
The recent market correction has led investors to ask whether it was FPIs that pushed the stock prices so low so fast. The domestic investors did not panic during this correction even as various fund houses reassured that there was no serious redemption pressure on fund houses in spite of the Franklin Templeton fiasco which led to the winding up of at least six debt-oriented mutual fund schemes. FPIs put together sold roughly Rs 61,972 crore in March. Now that is massive selling pressure for the Indian markets – never before had Indian markets faced such selling pressure. It indeed was unprecedented!

Highest Selling Months by FPIs 

✔ October 2018: Rs 20,000 crore.
✔ October 2008: Rs 14,000 crore.
✔ March 2020: Rs 61,972 crore.

How big this Rs 61,972 crore equity selling pressure is can be assessed by the fact that we have been celebrating funds (equity) inflow of Rs 6,000 to Rs 10,000 crore every month from domestic investors. There should be no doubt that the current vertical fall in March 2020 was triggered by FPIs and FPIs alone. On top of it there was a record redemption in debt markets to the tune of Rs 56,000 crore. So we can say that more than Rs 1 lakh crore was redeemed in March alone.

That is huge by any standard and can definitely move the markets with the given size of indian equity market. In 2020, so far FPIs have sold Indian equities worth Rs 55,748 crore. In 2008, the year known for its global financial crisis, the total equity outflow amounted to Rs 52,986 crore. The year 2008 saw markets correct by more than 50 per cent while in 2020 we are down by approximately 22.7 per cent on an YTD basis. We could say that due to strong domestic inflows, the Indian market’s catastrophic fall was relatively arrested. 

The United States of America leads in terms of total market capitalization in the world. As of 2018, the market capitalization in the United States was USD 30,436,313 million which accounted for 45.02 per cent of the world’s market capitalization. The top 5 countries (others being China, Japan, Hong Kong and France) accounted for 71.37 per cent. The world’s total market capitalization was estimated at USD 67,599,996 million in 2018. 

P Notes

For investing in Indian securities, all investors must be registered with the Securities and Exchange Board of India (SEBI). Participatory Notes also commonly known as P-Notes are financial or derivative instruments issued by FIIs to unregistered investors in other countries than India, allowing them to invest in Indian securities without the need of registration. P-Notes basically are offshore derivative instruments with Indian shares as underlying assets.

Hence, brokers and foreign institutional investors registered with the SEBI issue the participatory notes and invest on behalf of the foreign investors. P-Notes are beneficial since they provide access to quick money to the Indian capital market. But for the use of P-Notes, Indian regulatory authorities over time have expressed concerns relating to anonymity.

It is difficult for the regulators to determine the actual owner of the P-Notes. Hence, substantial amounts of unaccounted for money entering the country through P-Notes as well as the instrument's use for money laundering or other illegal activities is a key threat.

Because of its this nature of being opaque and due the constraints of not being able to identify the end investor, the Indian government and SEBI frown upon the popularity of P-Notes. This has caused SEBI to implement various strict norms for P-Notes. It has previously banned P-Notes subscribers’ from taking any unhedged positions in the Indian derivative markets so as to discourage use of the instrument.

Why did the global market rally in April?

Here are the reasons 
✔Global stimulus and liquidity.
✔Crude oil production cut agreement.
✔ Hope of vaccine for curing corona virus.
✔Several economies opening up gradually.

Market Concerns

✔India has not announced stimulus yet and hence will it underperform the global markets?
✔ Whether the global stimulus is enough?
✔ Will the opening of several economies lead to heightened infection rates?
✔ Whether the recovery will be V-shaped or U-shaped?
✔Collapse in corporate earnings.

FPIs and Negative Impact
History indicates that India has not been totally comfortable with foreign money. Ever since the FPIs have been allowed to invest in India since 1992, there have been instances where the government has attempted to curb the flows coming into India with the deep fear of the money being tainted and or owned by the enemy country of India. In 2007, when P Chidambaram was the erstwhile finance minister, he announced banning of P-Notes, only to later on clarify that P-Notes could continue to operate for the next five years.

News of banning of P-Notes sent the markets into a dizzy and pushed them into a lower circuit. India was the only market on that day that was under pressure while the global markets were rallying. This happened because FPIs became nervous and started selling whatever they owned. It was forced selling. This again highlights the significance of FPIs for capital-starved India and how FPI withdrawals can impact stock prices in India.

Recently when the People’s Bank of China (PBOC) increased its stake in HDFC from 0.8 per cent to 1.01 per cent from open markets when the stock prices crashed, it alarmed SEBI. It is believed that SEBI sent at least three missives to the custodians, requesting them to inform about the country of origin of investors, especially if the FPI investor belonged to Nepal, Pakistan, Mongolia, Bhutan, Afghanistan, Taiwan, Bangladesh, Myanmar, North Korea, Yemen or Iran. These countries are not usually buyers of Indian equities and it is always possible that China can invest in India though these countries taking advantage of sharply depreciated prices of Indian blue chip companies.

Therefore, there is always a risk of selling Indian equities and Indian economy to our enemy country and competitors. Also, there is a possibility of round tripping and the money coming into India via the FPI route may actually be of an Indian origin person who is simply routing the illegal money via ‘hawala’, using FPI facility meant for foreign money and investing back into the Indian stock markets. If we ignore these two risks, FPI money is essential for the capital market development of India and is actually healthy for Indian economy.

An important thing to remember here is that FPIs did not dump India alone. Just as in 2008, the current sell-off due to the pandemic is a global phenomenon. There was a global sell-off in equity asset class even as the world markets witnessed equity being sold to the tune of USD 450 billion in March 2020.

India saw exodus to the tune of USD 8 to 8.5 billion. One can state that FPIs are villains when India is being dumped in isolation and the buying continues in other global markets. That clearly was not the case in March 2020 and definitely it was not the case in 2008 when the markets crashed due to a global financial crisis.

A Currency Carry trade is a popular forex trading strategy where an investor sells a currency with a low-interest rate (eg. Japanese Yen) and then uses the funds to buy a new currency which is yielding a higher interest rate (eg. Indian Rupees). The investor stands to make a profit on the higheryielding currency as long as the currency exchange rate does not change. Many investors use currency carry trades, mainly because the gains can be very large, especially with leverage. 

Round Tripping refers to money that leaves the country through various channels and makes its way back in the form of foreign investment. This often entails black money and is allegedly often used for stock price manipulation. For example, routing of resident Indians' illicit money back into the country, mostly through tax-friendly nations like Mauritius, to avoid taxes.

What is interesting in the recent correction is the fact that the INR did not depreciate as much ad it did in some of the previous corrections. INR depreciated from 71 to 76 against USD which is somewhat less than 10 percent. In 2008 financial crisis, INR depreciated almost 20 percent while in 2013 correction where FPIs withdrew money , INR went from 55 to 68 versus USD which again reflects 20 percent correction.

Conclusion

It may sound outrageous to say that the development of the Indian capital market, and especially equity market, is permanently linked to the FPIs participating in India. However, one cannot deny the exuberance, liquidity, recognition and efficiency that FPIs bring to the Indian markets. FPIs may have sold to the tune of USD 8 billion in March 2020 but the FPI money can always come back once the current pandemic settles. MSCI and FTSE indices have increased their weightage for Indian markets and we can expect nearly USD 6 billion net passive inflows from these two ETFs over a year.

The Indian market is roughly 1.2 per cent of the global assets and it actually is miniscule when compared to other markets, especially developed markets. However, India is one of the fastest growing economies in the world and that makes all the global mutual funds allocate some percentage to India within the emerging market space. The recently announced global stimulus to tackle slowdown triggered by the pandemic lockdown has pumped in lot of liquidity in the global financial world, which suggests there will be increased asset allocation to equities in the coming quarters, even if the FPIs may have been frustrated with the lack of support announced to the industry in India.

Global fund managers cannot afford to miss being present in India. The gush of liquidity in the system will ensure the money flows back into the Indian markets. What happened in March was a margin call which led to forced sale of equity across the globe. We are in line with the US and other developed markets when it comes to the recent correction in March. Globally, the stock markets, bond markets, home mortgage markets and commercial paper markets were frozen and that led to panic sales driven by liquidity problems. Now the liquidity problem is behind us. The US Fed is doing better than expected and has actually promised to print unlimited amount of monies to support the financial system.

Jerome Powell, Chair of the Federal Reserve, is termed a ‘hero’ for not hesitating to go all out in support of the economy. Also, the RBI is being praised for its unprecedented support. Now the problem faced by several large and small economies is about how to revive the risk appetite and increase demand within the respective economies.

The reality is that only the central bank can influence the lending ability and is powerless when it comes to influence the demand for credit. The interest rates in most of the developed world are close to zero and hence there is every chance that the money will flow to risky assets such as equity. A pick-up in currency carry trades is also expected with the interest rates being as low as today. 

With pick-up in currency carry trade, emerging markets can be expected to witness increased fund flows. FPIs may look like the devils when they withdraw money the way they did in March 2020, but on closer inspection we find that they have, as a group, consistently shown faith in the growth story of India, much more than the Indian investors.

Once the markets normalise and a cure is found for the corona virus, the focus will shift to corporate earnings and profitability. That is when India may witness fund inflows much more than what has been withdrawn by the FPIs. FPIs thus are a true friend of emerging markets such as India in the longer run and higher FPI participation is desirable rather than the other way round.

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