FIIs back with a bang

Buy stocks worth $574 mn on Thursday, jamboree may continue if RBI reverses some of the earlier tightening measures

Sentiment is a major driver of equities and this has certainly turned for emerging markets such as India, after the US Federal Open Market Committee decided on Wednesday to defer the planned tapering of its quantitative easing programme. The move to keep the liquidity taps on has driven financial markets across the world to new highs; India is no exception.

The S&P BSE Sensex jumped 3.4 per cent to 20,646 points, its second biggest gain this year. Provisional data suggests foreign institutional investors (FIIs) bought equities worth $574 million (Rs 3,543 crore) on Thursday. FIIs had bought equities worth $1 billion up to the FOMC’s meet. Of the $4-billion selloff since May, Indian equities have already recouped $1.6 billion. The currency played ball, too, by rising 2.5 per cent to 61.78 a dollar on Thursday.

With its decision to defer the tapering of its bond purchase programme, the FOMC helped eliminate one of the biggest risks to Indian equities. Some of this had receded following Reserve Bank governor Raghuram Rajan’s quick-fix measures to prop the currency.

The rally should sustain on Friday’s policy review he reverses some of RBI’s earlier tightening. Abhay Laijawala, the India head at Deutsche Bank Markets Research, who has analysed FII flows after bouts of currency depreciation, says: “While it may be premature to conclude if the worst of the FII selling is over, we highlight anecdotal data which illustrates that since the global financial crisis, bouts of sharp currency depreciation in India have generally been followed by periods of strong FII inflows into equities.”

There are two episodes of strong FII buying after a sharp fall in the rupee. Between September and December 2011, it fell 13 per cent and this was followed by FII inflows cumulating $8 billion over the next three months. Similarly, it fell 11 per cent between March and June 2012,  followed by FII inflows of $6 bn over the next three months. Laijawala believes the velocity of inflows suggest this trend might continue if the currency stabilises. Also, what RBI does will be important for the markets, deciding further flows.

Frederic Neumann, co-head of Asian Economics Research at HSBC Global Research, says the FOMC decision is a big relief for Asia's hard-pressed emerging markets. He says things had stabilised in the past couple of weeks but the Fed's decision to keep pumping money should provide further lift. “Add to this the Bank of Japan’s aggressive monetary easing, which is only in its early stages, and financial conditions should stay highly supportive for a while longer. Even India and Indonesia, experiencing the greatest balance of payments pressures of late, should benefit nicely.”

With the US Fed deferring its tapering, Indian equities could see strong flows if some of the structural issues improve. Currency risk continues to be a major deal-breaker. The market is factoring in a 50-100 basis point cut in RBI’s Marginal Standing Facility rates. If this does not happen, they could react negatively. The head of fixed income at a foreign brokerage says if the fiscal deficit is not tamed and forex reserves are not recouped following Rajan’s measures, then India might not benefit from the easier liquidity conditions.