Sustained capital outflows from the capital market have unnerved stock markets and caused the rupee to weaken amid rising inflation across the globe. with the united states Federal Reserve poised to hike rates further, outflows are likely to continue, putting pressure on the Indian currency.
Why does the capital go out?
Foreign Portfolio Investors (FPIs), who hold around 19.5% of the market cap, have withdrawn Rs 42 billion in June so far, bringing total outflows to Rs 260 billion (33 000 million dollars) since October 2021. attributed to the tightening of monetary policy by the US. fed which has been on a wave of rate hikes to control inflation. Other central banks, including in Britain and the Eurozone, are following suit.
“Relatively high valuations in India, rising US bond yields, an appreciating dollar and concerns about the possibility of a US recession triggered by aggressive tightening are factors behind the IPF withdrawal,” said VK Vijayakumar, chief investment strategist at Geojit Financial. Services.
When the global economy took a hit, central banks around the world slashed interest rates and announced liberal monetary policies. While this helped economies recover and led to increased consumption, excess liquidity in the financial system led to inflation. This is the reason why central banks have started tightening monetary policies and raising interest rates. In India, inflation rose to an eight-year high of 7.79% in April, prompting the RBI to raise the repo rate at 90 basis points up to 4.90%.
How does it impact the markets and the rupee?
The pullback is dampening sentiment in equity and currency markets. The benchmark Sensex index has plunged 16% from the October 2021 high of 62,245.43 to 52,266.72 on June 23. The impact of the FPI sale on the markets is visible, with volatility rising and share prices falling. While this selling by foreign investors has been absorbed by domestic investors led by domestic institutional investors (DIIs) to a large extent so far, the flow of funds from retail investors and domestic institutions has slowed down of late. Between November 2021 and June 2022, the IIDs have invested a net amount of Rs 2,84,488 crore (over $37 billion) in Indian stocks, providing a counterweight. Experts say, however, that retail flow and DII inflows are weakening now, and markets could weaken further if FPI outflows continue.
India’s foreign exchange reserves have fallen by $46 billion in the past nine months to $596.45 billion as of June 10, 2022, mainly due to dollar appreciation and FPI withdrawals. The rupee has tumbled 7.3% to a record low of 78.30/32 against the dollar. The depreciation of the rupee is never good for the stock market in general, and the withdrawal of foreign investors can result in a decrease in investments in equity shares and mutual funds. Foreign investors generally stay away when the currency is falling and interest rates are rising in the US and developed markets.
Analysts said a lower rupee against the dollar keeps import bills higher, driving inflation even higher than it is now. Higher inflation is detrimental to the broader market. 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 like oil, gas, and chemicals. With the rupee falling, imports of oil and other imported components will become more expensive, further leading to higher inflation. Travelers and students studying abroad will have to shell out more rupees to buy dollars at banks. People are directly affected by the falling rupee as fuel prices soar.
How do IPFs work?
In times of global uncertainty, foreign investors adopt risk-averse trading, meaning they move money out of risky assets like stocks and add more bonds and gold. When interest rates rise in the US and other advanced economies, they withdraw money from emerging markets like India and invest in bonds in their home markets. The US 10-year bond has soared from a low of 0.54% in July 2020 to over 3.30% now.
“The global investment landscape has been hit by risk-off trading since October 2021 as central bankers hinted at policy tightening with inflation turning from ‘transient’ in nature to something of a pain. head in the medium term. This helped bond trading globally as yields started to become attractive, pushing investors to allocate a higher portion to fixed income as an asset class,” said a report from Axis Mutual Fund. Rising global yields is not good news for Indian equities and investors. The liquidation of FPI has led to a decline in the valuation of the top 500 companies, with some of them losing 15-20% in the last 9 months.
How big are they in India?
IPFs are the largest non-promoter shareholders in the Indian market and their investment decisions have a major influence on share prices and the general direction of the market. FPI holdings (in terms of value) in NSE-listed companies stood at Rs 51.99 lakh crore as of March 31, 2022, a decrease of 3.36% from Rs 53.80 lakh crore as of December 31 2021, due to the liquidation sustained since October 2021.
FPIs have sizeable stakes in private banks, technology companies, and large-cap companies like Reliance Industries. The US accounts for a major part of FPI’s investments at Rs 17.57 lakh crore as of May 2022, followed by Mauritius Rs 5.24 lakh crore, Singapore Rs 4.25 lakh crore and Luxembourg Rs 3.58. lakh crore, according to data available from the National Securities Depository Ltd. (NSDL).
Will the rupee fall further?
The rupee continued to depreciate beyond the general expectation of a gradual weakening despite the RBI selling its forex kitty dollars to stabilize the currency. At current dollar and spot rupee levels, year-end futures prices have moved above their projection of 79 per dollar by the end of 2022, according to a report from Bank of America Securities. “We believe the risks are still biased towards further rupee depreciation as the fundamental outlook has deteriorated further mainly due to rising oil and other commodities. We have adjusted our higher projection from 79 currently to 81 per dollar by the end of 2022. However, we see strong RBI reserves as a mitigating factor against tail risks,” he said.
Rising inflation in the US, rate hike concerns and stock market decline are weighing on sentiment for the rupee. On the other hand, further rate hikes by the Federal Reserve will lead to further outflows from foreign portfolio investors.
What should investors do?
If FPIs continue to exit and there is a drop in retail and DII participation, which market participants have noted in the recent past, equity markets may see a further correction. However, while other markets may further correct current levels, experts say investors should stick with their existing investments in domestic stocks.
“Although weakness is likely to continue in the markets, investors should not be looking to redeem their holdings in the current market. They should stay with them as a pick-up in economic activity, which is underway and could pick up steam in the next year or two, would result in future revival of markets and therefore gains for investors. ”, said the CIO with an asset management company. He further said that investors should not opt for lump sum investments and instead should continue with the systematic investment plan mode.