Spotlight on domestic flows as FIIs pull out of equities

After the slowdown of 2008 and 2009,equity markets recovered smartly in 2010 and outperformed all major markets in the world. For foreign investors,India became “the” place to put their money in. The party continued till November last year when markets tested the January 2008 highs of the BSE Sensex breaching the 21,000 mark. However,like the spectacular rise to 21,000,the downfall was equally dramatic. The reason: US equity markets recovered earlier than expected and Indian stock market became over-valued for the FIIs. In no time,they have started pulling out their investments and diverting the flows to the US.

Not a concern for long-term investors

While the market volatility may have forced traders to revisit their investment strategy and wait for the “right time”,it’s not bad news for the long-term investors. The improvement in the US equity market should not be a concern for the Indian markets,according to the Deutsche Bank. Its report suggests that “in the past decade,Indian equities have outperformed S&P 500 in all years when US equities have provided positive annual performance. ”

Though the long term story of India remains intact,there’re concerns on the short-term performance of Indian equity markets. Deutsche Bank’s ‘India Strategy Report’ says,“We expect the market to remain range-bound in immediate term particularly until there is some clarity on taming inflation.” For the near term,high inflation,rising asset prices and corruption related news would keep playing spoilsport,say market experts.

Experts are also seeing a new pattern of investment. FIIs are investing in India through the US corporates having a strong presence in India rather than directly putting their bet on Indian companies. Financial services firm Fullerton Securities says,“Companies like Coca-Cola,Pepsi,Nike,L’Oreal are some example of US corporates that have a strong presence in countries like India and China and are a good way for FIIs to play the consumption story without exposing themselves to risks associated with emerging markets like currency risk,lack of transparency etc. ”

This shows that FIIs believe in the long-term story of India,despite the near-term concerns. This also means that FIIs would look at returning to the Indian equity markets once the investment climate turns favourable and that can again take the equity markets to previous highs.

Need more domestic inflows

While FII money is always welcome for the Indian markets,excessive dependence on the FII money raises a question on whether Indian equity markets are stable enough as the domestic investors seem to have limited effect on taking the markets up. “As far as domestic institutions are concerned,they have less muscle in terms of taking grip of the markets as only 1% of the domestic saving goes in into stock markets directly or indirectly through mutual funds or life insurance companies. Recently from late calendar year 2010,we have seen that inflation fears and monetary tightening in emerging economies have raised some concerns on expected growth in the region,” says leading broking firm SMC.

Market experts have been raising voices in the past saying that the government must design the process and policies in such a way that the pension funds,part of provident fund corpus,money lying in banks,and mutual funds can increase their exposure in equity markets.“The over dependence on the FII money is not healthy for the Indian capital markets. The retail investor money should increase many fold which would bring more stability into the capital markets,” says capital market expert Prithvi Haldea. Experts,however,remain bullish on the long-term prospects for the Indian equity markets and advise picking up stocks on every downfall as the markets are expected to deliver good returns over a longer period.

ritukant.ojha@expressindia.com