Slowing growth a risk to foreign institutional flows

Indices languish below 2008 levels despite flows of $90 billion over six years; dollar returns down 34%

Towards the end of 2013, the collective belief in the market was a new government would end the muddled growth outlook for India. This optimism buoyed equities in the last few months of the calendar year. Other than this, the fundamentals of India remain unchanged. With elections drawing near, the outcome of change is also not clear, as economic growth for the past seven quarters has remained below five per cent.

Over the past six years, foreign institutional investors (FIIs) have invested $90 billion in Indian equities, but benchmark indices have still not managed to breach the levels of 2008. With potential growth rate falling from 8.5 per cent to five per cent, the rationale for risk capital coming to India also does not exist. Also, with the rupee falling by 19 per cent between January 2013 and January 2014, the dollar returns of Sensex have also been eroded. Portfolio flows came to emerging markets (EM) in search of growth, but with growth coming off, portfolio flows cannot be taken for granted.

This is visible in the outflows from emerging market funds since 2013. Manishi Raychaudhuri of BNP Paribas says EM funds suffered outflows of $13 billion since the beginning of 2013, including $26.1 billion since November 2013. The brunt of this selling has been faced by Thailand and Indonesia, where FII selling has hit a 10-year high. While India is not in that basket yet, the risks are not over. In contrast, since the beginning of 2013, North American equity funds have attracted almost $90 billion of inflows while western European funds have seen inflows of $65 billion. However, after the sell-off through 2013, some FIIs are looking at over-sold markets such as Indonesia. Since January, Indonesia has seen inflows of $825 million, while India has seen net inflows of $407 million, Brazil has received $136 million. Thailand has seen net selling of $1 billion.

Strategists say the world is a different place in 2014 from what it was in 2008. The drivers for steady FII flows are just not there. The BSE Dollex-30 Index, which indicates the dollar returns of the Sensex, has declined 34.4 per cent, while the Sensex has returned three per cent over the past six years. Elara Capital notes: “One needs to understand the import of five years of underperformance and take the expectation of flows in continuum with a pinch of salt. An impending rise in the pace of taper and a fractured mandate of the elections will bring about some moderation in flow data, if not outflows.”  Even if the Nifty breaches 7,000 points in the run-up to elections, strategists expect a correction as high inflation and tight monetary policy will keep earnings capped.