Learn to accept pain from FIIs, say experts

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Strict debt fund rules on anvilFIIs sell shares worth Rs 910 cr

: As long as FIIs have a major say in the Indian market, any adverse development in the global financial system will have a ripple effect here too, reports Bijith R

The credit crunch in the US economy as a result of the sub-prime mortgage crisis continues to haunt equity markets across the globe. First, it was the uncertainty surrounding the enormity of the crisis that led to a major sell-off across markets, regularly fuelled by news of liquidation of institutional fund houses which had a major exposure in the sub--prime market. Global markets still continue to reflect the developments in the US as clarity emerges, like the fact that the current crisis is not confined to a particular segment of the US economy. Now, it’s becoming clear that the crisis has spilled over to the broader economy and the facts and figures related to US retail sales, non-farm payrolls and employment data clearly point to the fact that the US is possibly heading towards a slowdown.

This is likely to effect the Indian equity market as well, for, though many argue that the Indian stock market is a symbol of India’s robust economic growth, India’s experience in the last one-and-a-half years has shown that the stock market has reacted to developments elsewhere in the world. In May 2006, when the US Federal Reserve decided to hike the interest rate, the Indian market witnessed a mass exodus by foreign institutional investors (FIIs), mainly hedge funds which had taken a highly leveraged position in the Indian equity market.

As a result, the 30-share Sensex of the Bombay Stock Exchange (BSE) fell by 3,687.94 points or 29.24% from a high of 12,612.38 points. Similarly in February 2007, Indian markets plunged sharply by 2,237.05 points or 15.26% from its life high of 14,652.09 points, as a result of unwinding of yen carry trade by global financial institutions when the Japanese yen appreciated sharply against the US dollar.

Currently, the market is experiencing a similar sharp fall in equity indices and a large bout of volatility, thanks to negative news flows emanating from the US economy. In August 2007, FIIs were net sellers of equity worth Rs 7,770.50 crore in the Indian market. During these period of crises, the domestic growth story remained intact with the Indian economy achieving a GDP growth of around 9% and India Inc. coming out with strong growth numbers.

Now, market participants are slowly coming to terms with the harsh reality that Indian capital markets can no longer rely only on the India growth story, but will have to learn to live with global macro-economic developments that could temporarily offset strong domestic fundamentals. Marketmen feel that with the present crisis impacting global liquidity, the risk perception of global investors has also changed and that they are finding comfort in parking their money in safer assets like government bonds and treasury bills. As a result, emerging equity markets, which are considered to be more risky compared to developed markets, may not be able to attract huge investment, at least for another six to seven months.

According to Apurva Shah, head of research, Prabhudas Lilladher: “There is no doubt that the stock market's basic strength lies in the strong India growth story.

But on the other hand, the market is heavily dependent on capital coming from different parts of the world that provide immense liquidity to the system. When any development directly impacts these players negatively, the Indian market is bound to get affected. If we can enjoy the benefit of an upward rally, the main drivers behind them being foreign players, we should also learn to take some pain on the downside when they book profits and make an exit.”

But the biggest question is whether domestic capital can play a more pro-active role in the Indian capital market to counter a sudden sell-off by foreign institutions and prevent potential damage to the financial system. The capital markets have already experienced sharp fluctuation in currency movement during this current crisis which could prove to be serious as was the case during the South East Asian economic crisis in the late nineties resulting from excessive outflow of portfolio money.

In August, when India witnessed a major sell-off by foreign players, domestic mutual funds bought equity worth Rs 4,093.90 crore in the market, thus providing some support at lower levels.

Sanjay Sinha, CIO, SBI Mutual Fund, said: “Domestic Institutional Investors constitute only10% of the ownership equity while FIIs’ ownership equity in the Indian market is around 22% which shows that the market is more tilted towards them. But on the positive side, in the last two years whenever the Indian mutual fund industry has turned net buyers after heavy selling by FIIs , we have witnessed a trend reversal in the Indian stock market.”

But market participants still feel that the domestic source of liquidity led by the Indian mutual fund industry and other financial institutions are no match to foreign investors who were the major drivers behind the bull rally in the past four years.

Shah added: “Theoretically, we can say that the mutual fund industry could play a more active role in the market and support it. But at the end of the day they are not here for supporting the Indian stock market, but to generate return for their investors.”