What has led to the sell-off by foreign portfolio investors? Does it affect the ongoing economic recovery?
What has led to the sell-off by foreign portfolio investors? Does it affect the ongoing economic recovery?
The story so far: Foreign portfolio investors (FPIs) have been on a selling spree in India. May figures of about ₹44,000 crore formed the highest monthly quantum of sell-off since March 2020 when India announced a nationwide lockdown. Last month was also the eighth on the trot that FPIs had sold net of their assets — i.e., sold more than they had purchased. Their selling actions have triggered a significant decline in benchmark indices resulting in a drop in market capitalisation of companies.
What are FPIs?
Foreign portfolio investors are those that invest funds in markets outside of their home turf. Their investments typically include equities, bonds and mutual funds. They are generally not active shareholders and do not exert any control over the companies whose shares they hold. The passive nature of their investment also allows them to enter or exit a stock at will and with ease.
What factors spur FPI moves?
Promise of attractive returns on the back of economic growth draws investors including FPIs into a country’s markets. For example, as per data from the National Securities Depositories Ltd. (NDSL), FPIs brought in about ₹3,682 crore in 2002. This grew to ₹1.79 lakh crore crore in 2010. This correlates with the concurrent expansion of economic output in that period, despite the 2008 global financial crisis which saw FPI sell-offs in that time-frame in the country. The year 2017 saw FPI inflows exceed ₹2 lakh crore.
Likewise, FPIs withdrew ₹1.18 lakh crore in March 2020 alone — the month when India announced a nationwide lockdown, triggering concerns around economic growth. In tandem, benchmark stock index Sensex fell from 42,270 in February 2020 to 25,630 in March 2020.
FPIs also show keenness to invest in bonds when there is a favourable differential between the real interest rates on offer in the country they aim to invest in, and other markets, but more specifically, compared with the largest economy in the world, the U.S.
Why have FPIs been selling India holdings?
FPIs sold assets worth ₹44,000 crore in May 2022. This is the second highest sell-off in a month since 1993, after March 2020.
Post-pandemic, recovery in the Indian economy has been uneven. The second wave of the COVID-19 pandemic in 2021 devastated lives and livelihoods. The economy stuttered again when a third, albeit less severe, wave saw the spread of the Omicron variant early this year. Add to this the return of pent-up demand in economies worldwide as the pandemic subsided. The pace of recovery caught suppliers off guard, contributing to supply-side shortages.
Even as industry was grappling with this challenge, Russia launched an attack on Ukraine. Sunflower oil and wheat supplies from these two nations were impacted, leading to a rise in global prices for these crops. As supplies in general tightened across the globe, commodity prices too rose and overall inflation accelerated. India witnessed a quickening pace in price rise that stayed above the Reserve Bank’s upper comfort level of 6% for four months running, touching 7.8% in April. Industrial production too has seen a bumpy ride without giving confidence of a full and final recovery from the pandemic. Consumption expenditure too has remained weak in the subcontinent.
With each of these factors contributing to a decline in confidence of robust economic performance, foreign portfolio investors have been reducing market investments over these past months.
Add to the mix the U.S. Federal Reserve raising the benchmark interest rate starting March this year. The key rate went up from 0-0.25% in March to 0.75-1% in May and is expected to rise by 50 basis points at each of the next two Fed meetings.
When the differential between the interest rates in the U.S. and other markets narrows, and if such an occurrence is accompanied by the strengthening of the dollar, then the ability of investors to realise healthy returns is impacted. For, returns are measured not only by the value appreciation of assets but also by exchange rate changes. If the dollar strengthens against the rupee, then an investor is able to realise fewer dollars for a given quantum of rupee assets liquidated. Further, if inflation quickens in the overseas market where the investor has placed funds, then the real returns are even further impacted.
They then tend to exit assets seen as ‘risky’ such as in emerging markets like India, Brazil or South Africa.
What impact does an FPI sell-off have?
When FPIs sell their holdings, and repatriate funds back to their home markets, the local currency takes a beating. After all, they sell rupees in exchange for their home market currency. As supply of the rupee in the market rises, its value declines. In this instance, the rupee has recently been seeing all-time lows. About a year ago, it was trading in the region of 73 to a U.S. dollar; it is now flirting with the 78 level. With a weaker rupee, we have to shell out more funds to import the same unit of goods. The most telling impact is on the cost of our crude oil imports that contribute to 85% of our oil needs.
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