A lot is being written about global investors and economists having a positive view about the emerging markets. Amongst the emerging markets, the BRIC nations - Brazil, Russia, India and China - are the few favourites. Among these, the latter two are preferred. Between the two, there are continuous debates underway.
However, considering that India's growth story along with it seeming to be a safer bet of the two, an increasing proportion of the global investing community is slanting towards India as a good long term investing opportunity.
Foreign institutional investors (FIIs) are certainly amongst the most influential set of investors in the Indian stock markets. Of course, there have been a lot of other factors at play like investments by domestic institutions and retail investors. But an argument can certainly be made that whenever FIIs have been strong buyers, BSE-Sensex has more often than not given good returns.
As you can see from the following chart, FIIs have been steadily and gradually been increasing their exposure towards the Indian markets over the past decade or so. Well, this is obviously by taking an exception of selected years such as 2002 and 2008.
|Data Source: CMIE
Hence, the kind of impact their buying has on Indian stock markets is certainly worth a look. Although it would be quite difficult to calculate their precise impact, we have attempted to work out the same.
We have taken the net FII inflow of a particular year and seen how the Sensex market cap has changed in that respective year.
|Data Source: CMIE, Equitymaster
*All the numbers have been rounded off to the nearest 100; Net cash flows considered
As can be seen in the above displayed chart, barring 2004, every time FIIs have bought stocks worth Rs 100, the Sensex has witnessed a market cap increase of a minimum of Rs 800, a ratio of 8:1. In fact, the number has gone as high as Rs 1,600 for every Rs 100 invested.
However, the average ratio for this period stands at about 10 to 1. This means that every time FIIs invested Rs 100 into the markets, the Sensex market cap rose by an average of about Rs 1000.
It must be noted that during bad times, such as the one we saw in 2008, FIIs tend to be the largest sellers as well. However, for the purpose of calculating the average gains in the market cap, we have not included the FII outflow of that one year.
In US$ terms, FII investors invested nearly US$ 18.5 bn during 2009. Prior to 2008, the net average FII inflows stood at about US$ 10.7 bn, US$ 8.4 bn and US$ 15.4 bn in 2005, 2006 and 2007 respectively (current foreign exchange rate 1 US$ = Rs 45.6).
The BSE-Sensex market cap stood at about Rs 25 trillion as of yesterday, while the BSE-Sensex stood at about 17,100 points. Now for the BSE-Sensex to touch 34,000 points, its market cap would be required to be at levels of Rs 51 trillion. This means Rs 25 trillion needs to be added to its market cap.
Now using the logic mentioned in a few paragraphs above, FIIs would be required to invest (net figure) nearly Rs 2.5 trillion (a ratio of 10 to 1) or US$ 55 bn.
US$ 55 bn is definitely an enormous sum. However, considering that the FIIs invested about US$ 18 bn (net investments) during 2009, this does not seem so farfetched. So, even if the Indian markets attract net FII inflows of about US$ 18 bn (as they did in 2009) annually over the next three years or so, Sensex could easily double from the current levels.
You might argue that this would be an aberration considering that the Indian markets were at their lows, and frontline stocks were available at very attractive valuations. However, a lot has changed since last year. And the investors expect things to gradually improve from here. However, even the FII investments may not top US$ 55 bn and we would still be there. But this would require the domestic institutions to let loose their purse strings in a big way!