One of the major reasons for the decline is because FPIs have shown a preference for other emerging markets (EMs) over India in recent years, as valuations of the Indian equity markets have turned high compared to other EMs.
Foreign portfolio investors (FPIs) have historically been the driving force of the Indian markets. However, over the years, their sway has dimmed as domestic inflows gained momentum. An analysis of FPI inflows shows that investments had been coming down over the years. Buying by FPIs in Indian equities sharply declined to approximately $18 billion in the last five years (CY 2014-18), from around $94 billion in the previous five years (CY2009-13), a report by IIFL Institutional Equities shows.
One of the major reasons for the decline is because FPIs have shown a preference for other emerging markets (EMs) over India in recent years, as valuations of the Indian equity markets have turned high compared to other EMs. “Profitability of Indian corporates has worsened over the last decade and the aggregate RoE of Indian equities is now similar to other EMs. Despite this narrowing gap of return ratios, Indian equities have continued to command richer valuation relative to EM equities. We believe this, too, would have played a role in the declining preference for India equity,” said the IIFL report.
Even as flows from FPIs slowed, mutual funds have become a popular vehicle for equity exposure in India and domestic inflows into Indian equities have picked up. Mutual funds collected $103 billion for equity investments in the last five years (CY14-18), compared with redemption of $6 billion in the previous five years (CY09-13). FPIs have remained sellers in the Indian equity markets and have offloaded stocks worth around $ 3.5 billion since the Budget was announced on July 5, which had proposed an increase in tax surcharge for FPIs.
Besides valuations of the Indian equity markets, US Fed’s decision to halt quantitative easing (QE) from October 2014 and to unwind its balance sheet from October 2017, did play a role in the deceleration, as many other emerging markets (EMs) also experienced decline in foreign flows into equity. While FPIs have reduced their exposure to the Indian markets, China was the largest recipient of FPI flows in the last five years, partly aided by the decision to include China A-shares in the MSCI EM index, which led to the rise in weight of China equities in the index.
While the deceleration in FPIs flows to EMs did drag down inflows to India, the country’s share in flows to EMs also dropped in the last five years. “Inflows to India accounted for only approximately 7% of FPIs equity inflows of the last five years (CY14-18), compared with around 20% share in the previous five years (CY09-13),” said the report.
However, FPIs have shown interest for Indian primary markets compared to secondary markets.