Foreign portfolio investor flows turn to a trickle as Fed taper nears

Net investment in Indian equity market lowest in 19 months

Monetary tightening by the world’s major central banks, including the US Federal Reserve (US Fed), has begun to negatively impact foreign capital inflows into India. There has been a sharp slowdown in equity investments by foreign portfolio investors (FPIs) after a big surge in the second half of 2020 and the first half of 2021.

The net FPI investment in the Indian equity market in the last 12 months has been the lowest in 19 months. The FPIs have made net investment worth $1.26 billion during the February 2021 and January 2022 period, down from $3.77 billion in the 12 months ended December. This is also 96 per cent lower than the record high of about $37 billion during the 12 months ended March 2021. 

The FPIs have turned net sellers in the current month as well. According to data from National Security Depository Services (NSDL), FPIs have been net sellers to tune of $532 million in the first two weeks of January. If this trend continues for the rest of the month, FPIs would be net sellers for the fourth consecutive month. They have now cumulatively withdrawn $5.3 billion since the beginning of October.

Analysts see this trend continuing in the foreseeable future, given the drawdown of quantitative easing and low interest rate regime by major central banks. “The monetary conditions have begun to tighten globally as major central banks start the process of monetary tapering and interest rate hikes to battle surging inflation in North America and Europe. This will dry-up capital inflows into emerging markets including India,” says Dhananjay Sinha, managing director and chief strategist JM Institutional Equity.

He expects little or no fresh FPI inflows into the Indian equity markets in financial year 2022-23 (FY23) if the US Fed sticks to its plan of ending asset purchases by March, followed by interest rate hikes.

Others see this as a result of recent changes in global growth dynamics. “There has been a sharp uptick in economic growth in developed markets in recent quarters. This has made investment in emerging markets like Indian much less attractive to FPIs, putting pressure on capital inflows,” says Madan Sabnavis, chief economist of Bank of Baroda.

Sabnavis says the Reserve Bank of India (RBI) may have to raise interest rates to attract capital inflows. “The biggest deterrent to higher capital inflows is the RBI’s low interest rate regime at a time when most central banks have either begun to raise rates or plan to do so,” he adds.

Interestingly, the slowdown in capital inflows comes at a time when the economy needs larger inflows to fund its rising trade and current account deficit (CAD). “The economy requires a higher level of FPI inflows to fund CAD, which is growing rapidly due to a sharp rise in crude oil prices and a general rise in imports,” says Sabnavis.

India’s total trade deficit (merchandise plus trade in services) surged to $87 billion in the 12 months ending December 2021, the highest since October 2019. It could rise further as the crude oil prices are back above $86 a barrel. This could translate into an even higher import bill in the coming months.