UBS expects retail flows into equity markets to slow amid rising rates

Meanwhile, the $23 billion net selling by FIIs (equity) in the Indian market year-to-date (YTD), is, when adjusted for FII AUM, the most intense in over a decade-surpassed only by the GFC, UBS said

Retail investor flows, along with domestic institutional money, has been the lifeline of Indian equity markets over the past few months at a time when foreign investors have deserted emerging markets (EMs) in the backdrop of rising inflation and a concerted central bank action to tighten the monetary policy. In a recent note, UBS said that it expects household flows into equities to slow as they soften with the reopening of the economy and avenues for consumption. 

“Household asset allocation decisions towards equities have a high dependence on bank deposit rates. As bank rates rise, we expect household flows to slow,” wrote Tanvee Gupta Jain, an economist at UBS in a co-authored note with Sunil Tirumalai.

Meanwhile, the $23 billion net selling by FIIs (equity) in the Indian market year-to-date (YTD), is, when adjusted for FII AUM, the most intense in over a decade—surpassed only by the global financial crisis, UBS said. The markets have tumbled as a result, with the S&P BSE Sensex slipping over 10 per cent thus far in calendar year 2022 (CY22), data show.

"Recent derating has pushed the Nifty 12-month forward price earnings ratio (PE) down to its five-year average. However, India remains expensive relative to emerging markets (EM). Therefore, while we believe the likelihood of FII selling is low, we are not confident of a quick reversal in FII flows. We are underweight on India relative to EM and our Nifty year-end target is 16,000," UBS said.

Those at Jefferies, too, expect the foreign investor flows to remain tepid across emerging markets, including India, amid rising rates in the developed markets. 

“Both policy makers and corporate India believe that inflationary pressures are peaking though June and September quarter will likely capture the full impact of higher costs. We do not believe that the FPI selling can reverse in a hurry despite strong fundamentals as valuations are still rich,” wrote Mahesh Nandurkar, managing director at Jefferies in a co-authored report with Abhinav Sinha.

Inflation woes

The brokerage met/spoke to over 50 foreign and domestic institutional investors over the past month in London, Singapore and India. The broad consensus among most investors, UBS said, was that global commodity prices would stay higher for longer, making inflation in India sticky at elevated levels. 

 

"Many investors believed that while the coordinated action between monetary and fiscal authorities over the past month to control rising inflation was a step in the right direction, it was not meaningful enough to soften inflation within the RBI's comfort zone (4 +/-2 per cent) unless global commodity prices moderate significantly. There is a possibility the government could announce more supply-side measures, including further reductions in taxes on petroleum products," the note said.

UBS' base case expectation for headline CPI inflation is to average 7 per cent YoY in FY23, with risks skewed to the upside. It sees the rupee at 80 levels to the US dollar in the next three months and expects the Reserve Bank of India (RBI) to hike the repo rate to 6.25 per cent by FY23-end.