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FIIs – Packing bags but going where?

by tavaga

Foreign Institutional Investors (FIIs) are critical to the Indian stock markets as they hold a significant stake in the Indian companies. FIIs have always been in a constant love and hate relationship with Indian markets. This relationship has off-late taken an ugly one-sided turn. FIIs have been deserting Indian markets every single month since October 2021, taking their total investment in Indian markets to a 9-year low.
From October 2021 to May 2022, FIIs have sold investments of about ₹20 billion. Sectors like IT, Real Estate, and Financials have been the worst hit. In fact, FIIs selling in the first 5 months of 2022 is higher than the total FII buying in 2021. Before this, similar selling by FIIs was seen in 2009 during the Global Financial Crisis when they pulled out $9.8 billion.
What is even more interesting is that despite this selling, domestic investors are not intimated and relentlessly pouring money into the markets. It is only because of them that Indian markets have only corrected by about 10.6% in 2022 so far while US markets have almost lost a quarter of their values.

Now, coming back to FIIs, why is this sudden change of heart?

Liquidity tightening, Inflation
Worldwide, massive liquidity tightening is underway. Central banks have been raising interest rates to tackle inflation and control liquidity post-pandemic. Most central banks had been pumping money into the system to revive economies post-pandemic downturn by purchasing bonds from financial institutions. This helped keep interest rates low. As central banks reduce such bond purchases and raise interest rates, investors are pulling money out of risky emerging markets and investing in treasury bonds of developed markets. High-interest rates affect the borrowing costs of companies, thereby impacting margins. It also reduces discretionary spending by consumers. Investors are therefore no longer willing to pay high valuations for Indian equities and pulling out their investments.

Depreciating rupee
In 2022, Indian Rupee compared to the US Dollar has fallen massively and is already down to its historic low breaching the 78 mark. FIIs’ earnings get impacted as they earn in INR but when they convert into their currency, they lose out due to depreciation. This was another reason for FIIs to exit India.

Ukraine Russia war
As if the world did not have enough problems, the Russia-Ukraine war raised the possibility of a full-fledged war causing an obvious panic among FIIs.

Everyone knows FIIs are selling and hence markets are down, but where are they going?
With Indian markets down, Europe and US markets down this year, where are FIIs investing this huge pool of money? The answer is, that it is shifting money from importers to exporters. Let us understand why.

Who is gaining?
The ongoing war has severely impacted the global supply chains which had just started recovering post-pandemic. Both Russia and Ukraine are key commodity exporters. Russia is one of the largest exporters of oil and energy products. Ukraine exports a large number of raw materials for iron, steel, mining, agriculture, chemical products, metals, and machinery.
This conflict has hampered commercial operations in both these countries, thereby leading to a spike in commodity prices. Oil prices have again breached the $120 mark which has had a ripple effect on other commodities too.
All those countries who have come out as an alternative to both these countries have been clear gainers of this war.

Brazil – is the 9th biggest producer of crude oil which has increased its exports to meet the Russian oil shortage. Brazilian equity benchmark Bovespa is down just 1% in 2022.

Thailand – Economy thrives on exports, forming 65% of its GDP. Thailand exports machinery and electrical goods partly compensating for the loss from Ukraine. The benchmark Thailand index Set is down just 4% in 2022 which includes this week’s fall of 2.2%.

Indonesia also gained from the war. Apart from oil and gas, the country also exports coal, steel, nickel, edible oil, etc. Not surprisingly, it made record-high exports in March of $26.5 million, up 44% YoY. Indonesia Sharia stock index is in fact up 6.2% in 2022 so far.
Thus it was a no-brainer investment opportunity and the FIIs are making the most of it.

When will this sell-off reverse?
The era of easy money is over. Such a funding crunch is more than evident in the startup space where VC funding has just dried owing to mounting losses on their existing investments. There is no hiding the fact that global sentiments point toward a rather bleak outlook in the near term. The current tightening program doesn’t augur well for the investments to return to India any time soon.
If the global tightening program eases or the geopolitical situation normalizes, we may see some inflows coming back. Back home, any strong positive signals either in terms of policy reforms or corporate earnings can also reverse this outflow.
Deep corrections in some good quality blue-chip Indian stocks may also attract FIIs back in search of value hunting.
In short, FPI flows may not provide too much support to India’s worsening current account deficit.
Clearly, for Indian investors, there is some more pain before we start seeing some gains.

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