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Why Foreign Investors Are Leaving India
28 MAY 2018
Foreign institutional investors(FIIs) have had a very important role to play in the Indian stock market as well as the Indian bond market, over the years.
Given this, it is important to keep track of how they are behaving at any point of time. As the old cliche goes, actions speak louder than words. It is totally possible that may say one thing and do another.
In 2018-2019 (i.e. April 1, 2019 onwards), the FIIs have sold stocks and bonds worth Rs 42,357 crore. Of this, the FIIs sold stocks worth Rs 13,371 crore and bonds worth Rs 28,986 crore, respectively. This after having bought stocks and bonds worth Rs 1,44,671 crore (Rs 25,635 crore worth of stocks and Rs 1,19,036 crore worth of bonds), in 2017-2018.
What made the FIIs change direction and how will things pan out in the days to come. Let's look at the situation pointwise.
1) First and foremost, the 10-year American treasury bond yield has had an upward trajectory since the beginning of this year (i.e. January 2017).
The 10-year American treasury bond yield at any point of time, is essentially the return an investor can expect to earn, by investing in an American treasury bond maturing in 10 years, at that point time, and then staying invested in it for 10 years. This yield acts as a sort of a benchmark for the overall interest rate scenario in the American economy.
Treasury bonds are essentially bonds issued by the American government to finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
2) At the end of December 2017, the 10-year American treasury bond yield was at around 2.4%. It started to rise after that and on May 17, 2018, this month, touched 3.12%. What has investing in India got to do with the American treasury yield?
In the aftermath of the financial crisis that started in September 2008, many big institutional investors started borrowing money in the United States and investing in stocks and bonds all across the world. The interest rates in the US were low because the Federal Reserve had decided to print money and push interest rates down. In the recent months, the Federal Reserve has decided to gradually withdraw the dollars that it had printed and pumped into the American financial system in order to drive down the interest rates.
As the Federal Reserve withdraws money, there will be fewer dollars going around in the financial system, hence, the interest rates are bound to go up.
The 10-year treasury yield going up is just an indication of the interest rates going up. At higher interest rates, the trade of borrowing in dollars in the United States and investing in India is not viable, which is why the FIIs have been withdrawing money from both bonds as well as stocks (and more bonds than stocks).
3) Of course, as FIIs withdrew from Indian stocks and bonds, it put pressure on the value of the rupee against the dollar. At the beginning of April 2018, one dollar was worth Rs 65. By May 24, 2018, it had touched Rs 68.7.
While, many FIIs selling stocks and bonds simultaneously, leads to the rupee falling against the dollar, the falling rupee can also lead to the FIIs selling out of stocks and bonds, which in turn can lead to a further fall of the rupee against the dollar.
Let's try and understand this in detail. When an FII sells (stocks or bonds) it gets paid in rupees. If it needs to repatriate this money, it needs to sell rupees and buy dollars. When many FIIs are selling rupees to buy dollars at the same time, the demand for the dollar goes up. This leads to the rupee losing value against the dollar.
So far so good.
Let's say an FII had invested a million dollars, when rupee was 65 to a dollar. In rupee terms, Rs 65 million or Rs 6.5 crore have been invested. Let's say a return of 2% has been earned on this investment over a couple of months. The investment is now worth Rs 66.3 million.
At this point, the dollar is worth Rs 66.3, as many FIIs are simultaneously selling out, hence, rupee has lost value against the dollar.
With the rupee falling against the dollar, the particular FII we are talking about in the example also decides to sell out, in order to protect its investment. When the FII sells its investment, it gets Rs 66.3 million. These rupees need to be converted into dollars.
This means that when the FII sells the rupees, it gets a million dollars (Rs 66.3 million divided by Rs 66.3). In dollar terms, no return has been made. If the dollar was worth Rs 67, then the FII would have actually lost money. Hence, it made sense for it sell out, before that situation was reached.
The point, as mentioned earlier, a falling rupee can lead to the FIIs selling out in order to protect their investment.
Of course, when this happens, it puts further pressure on the rupee. Beyond a point, we reach a stage, where the rupee is falling because the rupee is falling. (The rupee reached this stage a few days back, and has since, bounced back).
4) As the FIIs have sold out, the bond yields have gone up. In early April, the yield on a 10-year Indian government bond was 7.13%. It was at 7.87% as on May 24, 2018. Higher bond yields push up interest rates. At higher interest rates, many investors like to move their money from stocks to bonds and other debt securities.
5) In the last few days, things have improved. The rupee has gained against the dollar. As I write this one dollar is worth around Rs 67.4. The 10-year bond yield is at 7.75%. The 10-year American treasury bond yield is at 2.9%, down from 3.11%.
This has primarily happened because oil prices have briefly fallen. Forecasting, which way oil prices will go, is a tricky thing, given the multitude of factors involved. Nevertheless, the chances are that the prices will remain above $70-75 per barrel, until the initial public offering of Saudi Aramco, the biggest oil company in the world, is out of the way.
6) On the whole, FIIs will continue to exit India, as the era of easy money comes to an end. At the same time, it is worth remembering that the American dream, which is basically a consumerist one, runs on low interest rates. This is something that the Federal Reserve will have to deal with in the second half of the current year, where it will have to make a decision of whether it will allow the American interest rates to continue to go up or not.
Watch this space.
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