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Stable rupee, low inflation to herald return of FPIs

The central bank’s focus on inflation, market strategists believe, would contain any weakness in the rupee, making investments in equities and bonds attractive for FPIs.

While the Nifty50 had corrected 24.6% in 2011, the index yielded a moderate return of 3.2% in 2018.

The Reserve Bank of India’s surprise rate hike may help stem the sharp selloff by foreign portfolio investors (FPI), as it will arrest the rupee’s depreciation. The central bank’s focus on inflation, market strategists believe, would contain any weakness in the rupee, making investments in equities and bonds attractive for FPIs.

Untamed inflation, on the other hand, could see the currency depreciating causing capital outflows as returns are eroded. In the near-term, however, portfolio investors are expected to remain focused on the developments in the US, as their investments tend to track the movement in the Dollar Index, currently hovering at 103. When the dollar strengthens, foreign investors take risk off the table and wind down positions in riskier geographies like emerging markets. After hitting a low of 85 during the pandemic, the dollar index has been inching up steadily to a high of 103. Currency watchers don’t expect the dollar index to strengthen any further but they believe capital will flow in when the index starts trending down.

As Shrikant Chouhan, head — equity research at Kotak Securities, explains, typically when the dollar index strengthens, portfolio investors take risk off the table. “If the dollar index has achieved its extreme rise, then FPIs may come back. The highest that the dollar index has gone to was in July 2001, when it touched 120.90. Currently the dollar index is at 103.50,” RBI’s move will have a marginally positive impact on local currency, he says, as it will help slow the depreciation. “FPIs typically move back to risk assets when dollar index starts moving downwards,” he adds.

The dynamics of Indian markets have changed substantially in the last couple of years. Retail investors have been big buyers of equities supporting the markets against heavy selling by FPIs. The relentless selling by FPIs has seen their ownership falling to 19.5%, which is below the Covid lows. Indian investors have now become price setters rather than price takers, as their share in the overall listed space has gone up.

According to BoFA Securities, domestic institutional investors remained upbeat with monthly flows touching new highs at $6bn in March (up 19% MoM), crossing the $5bn mark for the second consecutive month. Up to March , hey had pumped in $14.6bn. In contrast, FPIs have been withdrawn $22.31 billion worth of shares since October last year, having made a killing during the pandemic.

Vivek Sharma, Head of International Clients Group at Edelweiss Wealth, observes that FPIs are taking home profits and reducing allocation to emerging markets. He believes FPI selling will continue in the short-term as it is driven by global factors. “Allocation to India is a part of the global allocation to EMs. Inflation coupled with rate hikes will revive risk aversion and risk-off trade. Once the situation normalises, local factors will come into play. The uncertainty around the world has to subside, which is when the markets will stabilize,” Sharma said.

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