Foreign liquidity is drying up in small-and mid-cap space: What this means

There are early signs that the recent boom in Indian stocks might be cooling down. This is because foreign investors, who were pouring money into India in 2023, are starting to slow down.

Lately, there's been a slowdown. The quantum of new money coming into India from other countries (foreign investors) has dropped significantly. This is the slowest it's been since May 2023 as investors in Europe (Luxembourg) are pulling out a lot of money (outflows) while investors in the US and Japan are also investing less in India compared to usual.

"We are finally witnessing initial signs of slowdown in India flows. Total inflows into India dedicated funds of $144mn (Large + Mid+ Small) are slowest since May’23. This is largely on back of big outflow of $256mn from Luxemburg domiciled funds while inflows from US and Japan domiciled funds also dropped by 55%-65% from average levels," noted Elara Securities in a note.

This is the first time in a year that people are taking money out of "India only" funds

"India dedicated Long-only funds saw their first redemption of $184mn in 1-year. India midcap funds had started taking slower outflows since Jan’24 but the pace has finally started expanding. The only place where India flows remain relatively strong was in ETFs. In CY23, India saw strong liquidity from both Foreign and Domestic investors. This created a frenzy in Small and Midcap space. Currently, the foreign liquidity is drying up in the small and mid-cap space which can slow down the price momentum. Need to closely monitor how the domestic liquidity shapes up from here," said Sunil Jain of Elara Securities.

What could this mean?

Historically, when foreign money slows down in smaller and mid-sized Indian companies (called "SMID"), their stock prices tend to cool down a bit. So far, the price momentum has been good, but this slowdown could change that.

"In past, India dedicated Midcap funds had seen strong inflows in 2014-2015 and 2017-2018 period. In the 2016 redemption cycle, Midcap stocks did not suffer as Domestic flows were very strong post Demonetization. In 2018-2020 Redemption cycle, Midcap stocks took a big beating as domestic liquidity also dried-up," explained Jain.

Here's a silver lining:

Unlike the past, Indian investors themselves might be able to pick up the slack. In the past, when foreign money dried up, Indian investor money helped stabilize the market.

Flows into India-dedicated mid-cap funds: Sum of ten weeks ( % AUM )

Another factor to consider:

China, a competitor to India in terms of attracting investments, is seeing a rise in foreign money. This might also be pulling some investment away from India.

"Along with the slowdown in India flows, foreign flows have shown some recovery in China with 7-week large inflow of $534 million. India has underperformed China by 10% from the peak, largest since Oct’22 period. This could be another trigger for liquidity shifting back into China for some time," said Jain.