FII flows: Are we still dependent on FII flows? Paradoxically, we

Every end of one year is the same as the beginning of the next year, but the beginning of a year is not necessarily the same as the end of the year. At the start of 2023, the Indian stock market was in stark contrast to where it was at the end of the year. As we move into 2023, activity in both primary and secondary markets has ground to a halt and halted. Most IPOs were pushed back and the secondary market was buzzing. At the time, no one expected that the end of the year would see the highest market levels with very active primary market activity. The number of IPO documents filed daily and advertised on the front pages of business newspapers is now unprecedented.

One of the much talked about interesting trends this year is the significant decline in foreign institutional investor (FII) holdings in our markets. Currently, out of India’s total market capitalization of $4.33 trillion, FII holdings are $656 billion (about 15%). This would be one of the lowest FII holdings in our stock market in the last 10 years. To put this in context, in 2012 FII holdings were ~25%. Nonetheless, our markets are at record highs. This is driven by another key trend: increasing domestic flows. The share of domestic individual and institutional investors increased from 25% in 2012 to 36% currently. Domestic inflows have increased significantly, especially through mutual fund channels.

With FII holdings at record lows and markets at record highs, the question that arises is whether we are finally decoupling from the FII flow. Are our markets no longer dependent on foreign flows? On the surface, the positive answer seems logical. But let’s look at some data related to this.

The country witnessed significantly low or negative FII flows in CY2021 and CY2022. In fact, FII flows were negative by USD 16.5 billion in 2022. In comparison, this year we have seen FII inflows reaching US$20 billion. These positive FII flows, following a period of significant negative flows, have played a significant role in the rise in Sensex and valuations. Without this shift in international flows, we would not have witnessed the levels of activity currently seen in both primary and secondary markets.

Moreover, foreign flows have started to shift more towards stable foreign direct investments (FDI) and away from hot money, which was previously mainly concentrated in portfolio investments. This improves the long-term stability of the funds compared to portfolio funds that can move in and out in the short term depending on market returns.

Since FII flows still play a significant role in the market, the question is what to expect from the market in the coming year. As I said, the market at the start of the new year is not an indicator of where it will be at the end of 2024. However, for now, we believe that overseas flows will continue. One simple reason is the expected interest rate reversal in the US. Traditionally, our flows are inversely proportional to U.S. interest rates. All expectations are that interest rates will begin to fall next year and that inflows will continue to grow. India has remained a premium beneficiary of foreign capital inflows. It is one of the major Asian countries receiving inflows of FII funds. In 2023, it will be the second largest beneficiary country in Asia after Japan. Among emerging markets, it is second only to Brazil. Therefore, overall FII flows should be substantially positive.

Of course, despite the upward trend in foreign capital inflows, we expect continued capital inflows from domestic investors to help reduce market volatility. With this, we hope that the good start to 2024 will remain positive throughout the year, unless something unpleasant happens.