A possible interest rate hike by the US Federal Reserve scheduled next week may increase the intensity of FII (foreign institutional investors) selling of domestic equities given that the domestic market enjoys significant overweight in EM portfolios.
In the last six years, the MSCI EM index has vastly underperformed its developed market counterpart in dollar terms, losing 20% of value as against more than 40% gains reported by the MSCI world index. MSCI India, on the other hand fared better reporting 31% gains in the period. Not surprisingly, It is estimated that currently FPIs have 250-300 basis points (bps) overweight on Indian market as against its 7%-8% weight in the MSCI EM index. At the market peak in January, these overweight stood in the range of 400-450 bps.
The latest bout of FPI selling, under which they have liquidated nearly $500 million worth of Indian shares in the last one week, indicate that at a time when fresh inflows are not making their way into the EM universe as a whole, India may see higher selling pressure as EM-focussed investors restructure their positioning. While comments form Fed Chair Yellen on December 2 when she cautioned against delaying a rate hike for too long, seems to have sparked this liquidation, FPIs as such have reduced their exposure to Indian shares by about $1.6 billion since November.
According to the foreign fund flow tracker report by Kotak Institutional Equities, which closely follows inflow by listed funds into India and EM peers, the total listed fund outflow from India amounted to $0.8 billion in November even as most EM regions saw weak participation by FPIs. It added that South Korea and China were preferred over India in October and active funds brought down their India exposure by 0.8-1% in October.
According to the head of equities of a domestic broking house, the overweight ‘savoured’ by Indian market could turn into a risk if investors start considering other EM markets on concluding that both in currency and stock market decline terms, enough damage is done for that particular EM peer. “A general apathy towards EMs, more earnings downgrades and monetary policy stagnation are the key risks facing domestic market over the next six months,” he added.
Even as FY16 consensus earnings estimates have declined by 20% in the year so far, Indian market currently trades at one-year forward earnings of 14.9 times, a steep premium to equity benchmarks of peers like South Korea, China and Indonesia that currently command forward earnings of 10.8, 13.44 and 13.9 times respectively, show Bloomberg data.