Challenges to be addressed in the FII sector and recent trends

India witnessed significantly lower or negative FII flows in Calendar Years 2021 and 2022. FII flows were negative US$ 16.5 billion in Calendar year 2022. FIIs have sold large amounts of Indian shares so far despite India’s strong corporate earnings and robust macroeconomic numbers. The major concern for FII’s could be valuations as the prices of shares have run up way ahead of fundamentals. According to financial experts, the selling by FPIs in equity would have been much higher in response to the rising US bond yields. Foreign investors seek opportunities where they can find reasonable valuation and growth. Financial services, construction, and telecom are some of the sectors in which FIIs have been reducing their exposure. The bearish view on banks is because of their inability to raise low-cost deposits even as credit growth has been fairly strong. If banks don’t get cheap funds, their profit margins will shrink.

The movements of foreign institutional investments in emerging markets like India are influenced by a variety of global economic, political, and financial factors in today’s highly interconnected world. The three main reasons behind the recent outflows from Indian equities are;

Whenever US Treasury bond yields increase fixed income returns in the US go up. This prompts foreign investors to shift their funds back to US markets from other regions for better returns. Moreover, higher US yields drive up global financing costs making emerging market investments appear less lucrative. The ongoing conflict between Russia and Ukraine, Israel, and Hamas has escalated geopolitical risks pushing up Brent crude oil prices sharply above $90 per barrel. Sustained high oil prices raise concerns about rising inflation globally. Geopolitical tensions in key oil-producing regions make investors wary of emerging markets like India which are dependent on crude imports. Further, Profit booking is also quite important when it comes to rebalancing investment portfolios. Having invested in Indian stocks over the past year, foreign investors booked some profits given the uncertain environment.

Currently of the total Indian market cap of US$ 4.33trillion, FII holding is 15% (US$ 656 billion) which is bottom-most compared to FII holding of 25% in 2012. This will be one of the lowest FII holdings in our stock markets over a decade. We may also notice that the foreign investment flows have started to move more towards stable Foreign Direct Investment (FDIs) from the earlier predominantly of portfolio investments.  Positively, investment towards FDI is better for the country as it offers more long-term stability of funds as compared to portfolio investments which can move in and out in the short term as per market returns.

India has been one of the key Asian countries to receive FII flows. In the Calendar Year 2023, India is the second largest recipient in Asia after Japan. Even among emergent markets, it is second to Brazil. Conventionally, inward flows to India are inversely proportionate to the US interest rates. India may attract the eyes of overseas investors in 2023 as well on account of measures such as the rollout of the production-linked incentive (PLI) schemes and the projection of healthy economic growth, though global economic uncertainties due to monetary policy tightening in the US. Hopefully, interest rates will start going down next year and therefore the inflow of money to India may continue to rise.