GR Exclusive: FPI Selloff; Why Foreign Investors Are Divesting From Stock Market Despite Record Highs?

In recent months, the Indian stock markets have experienced a notable trend of foreign portfolio investors (FPIs) pulling out their investments. This exodus, which culminated in withdrawals totalling over Rs 35,500 crore in May alone, has sparked concern and analysis across financial circles. Despite this significant outflow, the Indian markets have displayed remarkable resilience, reaching record highs multiple times. This apparent paradox is underpinned by a robust domestic investor base that has stepped up to fill the void left by foreign investors.

Several key factors have contributed to the steady divestment by FPIs from Indian stock markets:

High Valuations: Indian equities have been trading at high valuations, prompting FPIs to seek better opportunities in markets like China and Hong Kong, where valuations are comparatively lower.

US Federal Reserve Policies: Delays in the anticipated interest rate cuts by the US Federal Reserve have made US assets more attractive, further boosted by rising US bond yields.

Geopolitical Tensions: Heightened tensions in the Middle East and the strength of the US dollar have added to the global risk-averse sentiment, leading FPIs to reallocate their investments.

Chinese Market Appeal: Chinese tech stocks, buoyed by better-than-expected earnings, increased buybacks, and dividends, have drawn investors back. The easing of Beijing's regulatory crackdown has also contributed to a more favourable outlook for Chinese equities.

The Role of Domestic Investors

Despite the heavy FPI selling, the Indian stock markets have remained robust, thanks largely to the active participation of domestic institutional investors (DIIs) and retail investors. In May, while FPIs withdrew Rs 35,527 crore, DIIs injected Rs 41,720 crore into the markets. This influx has been crucial in maintaining market stability and driving indices to new heights.

On May 27, the Nifty 50 reached a record high of 23,100 points, marking its fourth new high in the month. Similarly, the Sensex hit a lifetime high of 76,009 points, setting record highs three times in May.

A Shift in Investment Trends

Traditionally, Indian households favoured bank deposits for their savings due to the perceived safety and stability they offered over the volatility of the stock market. However, recent trends show a significant shift, especially among younger investors. The record opening of 32 million demat accounts in FY24 and the continuous positive inflows into mutual funds for 38 consecutive months as of April highlight this trend.

The number of SIP (Systematic Investment Plan) accounts reached a new high of 8,70,11,401 in April, reflecting a growing willingness among domestic investors to embrace risk and diversify their investment portfolios. This shift has significantly narrowed the ownership gap between foreign and domestic institutional investors.

Changing Ownership Dynamics

At the end of the March quarter, foreign investor holdings in NSE-listed companies fell to an 11-year low of 17.7%, while domestic investor holdings surged to 16.1%. This marked a transformation in the ownership space of Indian equities, with the difference between FII and DII ownership narrowing to 1.6%, down from 10.3% in March 2015.

This changing dynamic is not only significant for the stock market but also indicative of a broader economic shift. The growing confidence of domestic investors in their home market shows a maturation of investment behaviours and a greater willingness to take on calculated risks for potentially higher returns.

Sectoral Impact

FPIs have notably reduced their holdings in certain sectors. The IT sector, for instance, saw heavy selling, with FPIs offloading Rs 5,574 crore worth of shares in the first half of May, following a sell-off of Rs 9,573 crore in April. The FMCG sector also witnessed outflows of Rs 1,158 crore in the first fortnight of May after outflows of Rs 7,914 crore in April.

Analysts believe that the heavy FPI selling in the financial sector was primarily driven by profit-booking and should not be viewed as a sign of waning confidence in the sector. "India witnessed the worst foreign institutional investor (FII) selloff of $5.4 billion among major emerging markets in May. This exodus stemmed from global risk-off sentiment amid recession fears, aggressive monetary tightening, and geopolitical tensions. Domestically, higher inflation, rupee depreciation, and the potential impact of the Russia-Ukraine conflict exacerbated the selloff. However, India's strong economic fundamentals and resilient corporate sector could attract FII inflows ahead," said Atul Parakh, CEO of Bigul.

Global and Domestic Market Dynamics

India's strong economic fundamentals and resilient corporate sector have played a crucial role in attracting and retaining investor interest. Despite the outflows, India's growth story remains compelling. The country's inclusion in various global bond indices has also attracted foreign investment into its debt market.

Overseas investors have infused nearly Rs 47,000 crore into India's debt market in 2024, with positive inflows in every month except April. This shift is partly driven by India's upcoming inclusion in the JP Morgan Government Bond Index-Emerging Markets, anticipated to bring substantial inflows starting June 2024.

Election-Related Uncertainties

Domestic political uncertainties, particularly related to the upcoming Lok Sabha elections, have also contributed to FPI selling. Election outcomes can significantly impact market sentiment, and foreign investors have adopted a cautious stance in light of the perceived ambiguities.

"India finds itself at the forefront of foreign fund outflows among emerging markets for the month of May, a phenomenon attributed largely to election-related uncertainties sending ripples of panic across Dalal Street. The apprehension stems from the perceived ambiguity surrounding the outcome of the Lok Sabha elections, exacerbated by lower-than-anticipated voter turnout. FIIs have shown a propensity to offload Indian stocks in nearly all trading sessions this month, a trend discernible from provisional NSE data," said Anshul Jain, Head of Research, Lakshmishree Investments & Securities Ltd.

"The electoral uncertainty serves as a primary catalyst prompting Foreign Institutional Investors to adopt a cautious stance towards Indian markets. However, it's imperative to recognize that electoral dynamics are not the sole determinants of FII behaviour in Indian equities. Elevated market valuations and profit-taking activities following a robust market rally contribute significantly to FII divestment decisions," Jain added.

"A noteworthy aspect contributing to the selloff narrative is the notable surge in Chinese equities, exemplified by a remarkable 20% uptick in the Hang Seng index between April 19 and May 20. This remarkable performance of Chinese stocks, juxtaposed against relatively lower valuations, has piqued the interest of Foreign Portfolio Investors (FPIs), prompting a shift in investment focus from relatively expensive Indian equities to attractively priced Chinese counterparts. India's FII outflows in May reverberate across other emerging markets, with Indonesia, Vietnam, and Thailand also experiencing similar trends. Conversely, Taiwan emerges as a standout performer, recording substantial inflows totalling $6.27 billion among emerging market nations. Noteworthy inflows were also observed in South Korea and Malaysia during the same period," Jain stated further.

A victory for the Narendra Modi-led Bharatiya Janata Party (BJP) in the elections 2024 is likely to see foreign portfolio investors (FPIs) return to Indian shores, said analysts at Nomura, who pegged their weekly inflow to the tune of $1 - 2 billion into the debt markets till the JP Morgan index inclusion date (June 28). Conversely, if the BJP fails to win the election 2024, which is not their base case, Nomura expects outflows from the forex channel to be over $30 billion in a couple of weeks, which would require heavy intervention from the Reserve Bank of India (RBI).

While FPIs have been selling off their equity holdings, they have simultaneously increased their activity in the country's debt market. This shift is largely driven by the anticipation of India's inclusion in global bond indices, which is expected to bring substantial inflows into Indian government bonds.

Foreign investors pumped in over Rs 7,400 crore into Indian debt securities in May on a net basis, compared to a net sell-off of over Rs 11,200 crore in April 2024. This inflow is primarily due to the expected inclusion of Indian government bonds in the JP Morgan Government Bond Index-Emerging Markets in June 2024.

With the anticipated inclusion, experts believe that India could garner total inflows close to $30 billion in fiscal year 2024-25 (FY25). There will be an investment in over 23 Indian government bonds with a notional value of approximately $330 billion, analysts said. In addition to the JP Morgan index, Indian securities are also expected to be included in the Bloomberg EM local currency government Index, potentially adding 34 Indian securities by January 2025 with an initial weightage of 10%.

The Indian stock markets are navigating complexities marked by significant FPI withdrawals, robust domestic participation, and evolving global and domestic dynamics. While foreign investors are drawn to lower valuations and stronger growth prospects elsewhere, domestic investors' increasing participation and India's strong economic fundamentals provide a solid foundation for continued market resilience.

The interplay between domestic and foreign investors will remain a critical factor in shaping the future trajectory of Indian equities. The ongoing transformation in investment patterns highlights the growing maturity and confidence of domestic investors, setting the stage for a more balanced and dynamic market environment.

As India continues to attract and adapt to varying investment flows, the resilience of its stock markets will likely be tested. However, the robust participation of domestic investors and the country's strong economic fundamentals suggest that the Indian markets are well-positioned to sail through these challenges and continue on their growth trajectory.