FPI Exodus

The net outflow of foreign portfolio investments has increased significantly since the start of 2022. So far, the FPIs have pulled out more than ₹1.81 lakh crores from the equity market. Let alone in June’22, the FPIs removed a whopping ₹57,137 crores from the equity market. BSE Sensex and NSE Nifty50 have lost 13% and 12%, respectively, from the lifetime highs touched in October – incidentally, the month in which the FPIs started selling.

FPIs play an important role in Indian economy. Inflow (outflow) of foreign currency indicates increase (decrease) in demand for Indian rupee leading to appreciation (depreciation) of the rupee. The massive sell-off by FPIs has led to rupee depreciation which will put a pressure on import bills of the country.

Let’s understand the economics behind the sell-off…

Foreign portfolio investors always yearn for a higher return on their investments and hence they look for investing in countries with higher interest rates. Yield spreads are typically the primary driver behind FPI flows. As the yield differential increases between India and US bonds, Indian markets become more attractive for foreign investors, and vice versa. In order to reduce inflation in the US, the Fed has consistently raised interest rates. The realized spread between Indian and US 10-year bond yields has fallen significantly from around 550 bps in March 2020 to 430 bps now.

India is an emerging country with high growth potential. However, global tensions continue to impact the economy adversely. The huge shortage of commodities (crude oil, energy, copper, wheat, etc.) globally has inflated their prices since the Russia-Ukraine war started. The foreign portfolio investors have turned negative due to high inflation, rupee depreciation, and an increase in the fiscal deficit. The weakening of the rupee diminishes the attractiveness of the assets in emerging economies. It erodes the FPI’s returns from Indian assets.

In the near term, FPIs expect the markets to correct which will depend on the status of the war, the Fed’s policy, and the revival of Chinese supply. Unless US inflation softens, the RBI’s rate hikes won’t be able to meet with expectations of hikes by the Fed. Persistent high inflation will dampen the future demand recovery and this will add fuel to the next recession. The demand for risky assets, such as Indian equities, is going to remain low until the combined effect of high inflation and slowing growth is nullified.

Thank you.

Regards,

Hritika More,

Kautilya,

IBS Mumbai.