Mar 9, 2005|
FIIs: Bumpy road ahead?
The Indian indices have been making new highs almost everyday since the last few trading sessions and it is now a well known fact that the one big pillar supporting this rally, now in its third year, are the Foreign Institutional Investors (FIIs)). Relentless FII inflows during this period have helped the Indian indices more than double since the start of 2003. In this article we take a look at how has the FII inflows been over the last few years, the impact they have had on various Indian indices and what is the possibility of the same continuing.
* As on March 7, 2005
||FII inflows (US$ m)
The table above indicates the quantum of FII inflows into the country over the last 3 years and their impact on various indices. As can be seen above, FII inflows have gathered significant momentum since 2003. After a rather poor net inflow in 2002 (about US$ 740 m compared to US$ 2.8 bn in 2001), 2003 and 2004 have seen very strong inflows of US$ 6.6 and US$ 8.5 bn respectively. Continuing with the trend, the money poured by them into Indian equities has been much stronger in the first two months of the current calendar year. Further, just to put things in perspective, FIIs have invested close to US$ 33 bn into Indian stockmarkets to date, approximately 55% of which have come in the last 24-30 months, the reasons for which have been provided time and gain on our website.
* YoY as on March 7, 2005
| (% change)
The table above, derived from the previous table, gives a much clear picture as to the growth in FII inflows and the corresponding behaviour of the indices during this period. As the table above indicates, the big push to the Indian indices was provided in 2003 when the Sensex surged by 73% on the back of strong FII inflows. This flow sustained right through 2004 helping the Sensex notch another 13% gains. Improving fundamentals of India Inc. has made the country amongst the most sought after emerging market destinations for equity investments. This is vindicated by the fact that despite the eye-popping investments by FIIs in 2004, the flow has only gathered further momentum in 2005 as yet, as is evident from the 74% YoY growth in FII inflows to date in 2005. Further, a budget focused on spending on agriculture, irrigation and infrastructure has only provided further impetus to FII inflows.
It must also be noted that in 2005, India has outperformed most Asian markets in terms of receiving FII monies. Also, it must be noted that some of this money has seemingly been invested in mid-cap stocks as is evident from the near 150% gains in BSE-500 compared to about 100% of the BSE-Sensex. The relatively stronger growth amongst mid-cap stocks could partially be attributed to the fact that most of the index and 'A' group stocks are already sufficiently/over owned by FIIs and so a significant portion of the incremental investments could have found their way into second-rung but fundamentally strong companies.
Since FIIs have been and continue to be the pillars of the Indian stock-market rally, the risk increases all the more while investing in Indian equities. This is on the basis that since this is not 'our' money that is finding its way into Indian equities, the 'owners' could take it back to their respective countries or to other destinations where investments become relatively more or equally lucrative in terms of returns. And one big development that could see this possibility come true is the sustained economic growth of the US economy, which would lead to hardening of interest rates going forward in order to keep a check on any inflationary pressures building up in the economy.
While a certain faction of the market (including us) believed that with interest rates going up in the US in 2004, FII money would flow to that country, this did not happen. When we tried to find the reason for the same from Mr. Ajit Dayal, Chairman, Quantum Information Services Ltd. and Quantum Advisors, he explained, "... you are right that interest rates (in the US) have more than doubled. But they doubled on a lower base. At 2.25%, I as a long-term pension fund investor, I am still saying international markets look good and equities look great. But if you start giving me 3.5% or 4% cash, when rates go to that level, then I will start thinking. Then, there is a real alternative. So even though interest rates doubled, in absolute numbers, they are not that attractive to result in an asset shift."
He further added, "The first thing is from equities to fixed income and then globally, from international stocks back to the US. So, I think you have got to wait for that threshold limit and the limit from what I have explained to you, is somewhere between 3.5% to 4%. And in this year, we are going to hit that threshold limit, probably the upper end. At 4%, dead cash is a real alternative. Because, if this is near-term money, long-term money is probably closer to 6%. Then, suddenly, you have these pension funds scratching their head and saying do I need to go through all the risk of anywhere in the world or should I just be in the US?" Read full interview
Though there have been a slew of positive announcements in the recent past with respect to attracting domestic investors' money into equities, which include that of zero tax on long-term equity investments (10% on short-term) and a higher permissible investing limit (if desired) upto Rs 1 lakh in equity-linked saving schemes (ELSS) that could be claimed as a deduction from the taxable income, the impact of this would take some time to materialise.
However, we must re-iterate here that while we are not saying that FII money will dry up completely, we believe that even a slowdown on this front would prevent the indices from making significant gains. This is considering the strong correlation of Indian indices with FII inflows, as there is an absence of a strong domestic investor base to fill the gap that would be created in the event FIIs decide to pull out. And thus, to that extent, investors need to be cautious and temper down their expectations from equities from hereon.
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