What FPIs’ market exit means

The constant outflows of capital from the capital market have strained the stock markets and weakened the rupee amid rising inflation across the world. As the US Federal Reserve prepares to raise interest rates further, outflows are likely to continue, putting pressure on the Indian currency.

Why is capital flowing?

Foreign Portfolio Investors (FPIs), who own about 19.5% of the market capitalization, have withdrawn Rs 42,000 crore in June so far, bringing their total outflows to Rs 260,000 crore ($33 billion) since October 2021. The sale of the FPI is attributable to Tightening of monetary policy by the US Federal Reserve which was in the case of a rise in interest rates to control inflation. Other central banks, including in Britain and the eurozone, are following suit.

“Relatively high valuations in India, rising bond yields in the US, a stronger dollar, and concerns about a possible recession in the US due to violent tightening are factors behind the withdrawal of FPIs,” said VK Vijayakumar, senior investment analyst at Geojit Financial. services.

When the global economy took a hit, central banks around the world cut interest rates and announced liberal monetary policies. While this helped economies recover and led to higher consumption, the excess liquidity in the financial system led to inflation. This is why central banks have begun to tighten monetary policies and raise interest rates. In India, inflation rose to an eight-year high of 7.79% in April, prompting the Reserve Bank of India to raise its repo rate by 90 basis points to 4.90%.

How does it affect the markets and the rupee?

The withdrawal dampened sentiment in the stock and forex markets. The benchmark Sensex is down 16% from its October 2021 high of 6,2245.43 to 5,2266.72 on June 23. The effect of selling the foreign investment index on the markets is evident, with increased volatility and lower stock prices. While this sale by foreign investors has been largely absorbed by domestic investors led by domestic institutional investors (DIIs) thus far, the inflow of funds from local retail and institutional investors has slowed down recently. Between November 2021 and June 2022, DIIs invested a net 2,84,488 crore (more than $37 billion) in Indian stocks, providing some offsetting. Experts say, however, that retail and DII flows are weakening now, and markets may weaken further if FPI outflows continue.

India’s foreign exchange reserves fell by $46 billion in the past nine months to $596.45 billion on June 10, 2022, mainly due to the rising dollar and the withdrawal of the FPI. The rupee fell 7.3% to an all-time low of 78.30/32 against the dollar. A depreciation of the rupee is not good for the stock market in general, and the withdrawal of foreign investors can lead to a decline in stocks and mutual fund investments in stocks. Foreign investors generally turn away when the currency is declining and interest rates are rising in the United States and developed markets.

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Analysts said the rupee’s decline against the dollar keeps import bills higher, driving inflation higher than it is now. High inflation hurts the market as a whole. If the rupee does not strengthen, FPI outflows will continue, which is another negative. A strong dollar is good for export-oriented companies, but bad for import-oriented industries such as oil, gas, and chemicals. With the fall in the rupee, imports of oil and other imported components will become more expensive, which will lead to increased inflation. Travelers and students studying abroad will have to pay more rupees to buy dollars from banks. People are directly affected by the depreciation of the rupee with the rise in fuel prices.

How do FPIs work?

In times of global uncertainty, foreign investors are adopting risk-free trading, which means they move money out of risky assets like stocks and add more bonds and gold. When interest rates rise in the United States and other advanced economies, they withdraw money from emerging markets such as India and invest in bonds in their home markets. US 10-year bonds have risen from 0.54% in July 2020 to more than 3.30% now.

The global investment scenario has been plagued by risk-aversion trading since October 2021, with central bankers hinting at a tightening of policy with inflation moving from being ‘temporary’ in nature to a somewhat mid-term headache. This has helped bond trading globally as returns are starting to become attractive, prompting investors to allocate a higher portion toward fixed income as an asset class, according to an Axis Mutual Fund report. The rise in global returns is not good news for Indian stocks and investors. The sale of the FPI led to a decline in the valuation of the 500 largest companies, with some losing 15-20% in the past nine months.

How big are they in India?

FPIs are the largest non-promoter contributors in the Indian market and their investment decisions have a significant impact on stock prices and the general direction of the market. The ownership of FPIs (in terms of value) in the NSE listed companies was Rs 51.99 lakh crore as on March 31, 2022, a decrease of 3.36% from Rs.

FIIs own large stakes in private banks, technology companies and big capital such as Reliance Industries. The US accounts for a large portion of FPI investment at Rs 17.57 crore as of May 2022, followed by Mauritius at Rs 5.24 crore, Singapore Rs 4.25 crore and Luxembourg Rs 3.58 crore, according to data available from National Securities Depository Ltd (NSDL).

Will the rupee depreciate further?

The rupee continued to depreciate beyond public expectations of gradual weakening despite the Reserve Bank of India selling dollars from its foreign exchange fund to stabilize the currency. A report by Bank of America Securities said that at current dollar-denominated rupee levels, year-end forward prices have exceeded their forecast of 79 per dollar by the end of 2022. “We believe risks remain skewed towards further depreciation of the rupee as the underlying outlook has further deteriorated. Due to higher oil and other commodity prices. We have revised our forecast above currently 79 to 81 per dollar at the end of 2022. However, we see the strong reserves of the Reserve Bank of India as a mitigating factor against tail risks.”

Rising inflation in the US, concerns about interest rate hikes, and a slumping stock market are all weighing on the sentiment of the rupee. On the other hand, further rate hikes by the Federal Reserve will lead to increased outflows from foreign portfolio investors.

What should investors do?

If FPI continues to outflow and there is a drop in retail participation and DII participation, which market participants have noticed in the recent past, the stock markets may see a further correction. However, while other markets may correct more than current levels, experts say investors should stick with their current investments in local stocks.

“Even as market weakness likely continues, investors should not look to redeem their holdings in the current market. They should stay with them as a recovery in economic activity is on the way and could gain momentum over the next year or two, reviving the markets The future and thus gains for investors,” the asset management company. He further said that investors should not go into huge investments and instead should continue to put in place a regular investment plan.

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