Why do FPIs keep selling? From high valuations to a changed narrative

Selling by foreign portfolio investors (FPI) has continued almost nonstop since October 2024 — 18 months and counting. We have seen outflows of over $45 billion, and in the past month, this accelerated to nearly $1 billion on certain days. This amounts to almost 1 per cent of market capitalisation, exceeding the selling witnessed even during the global financial crisis (GFC). I have seen research from investment banks forecasting another $12-15 billion of possible selldown, based on prior metrics.

 

Foreign Investors are now seriously underweight India, with ownership at a 15-year low. India has underperformed emerging market (EM) equities by 5,000 basis points. Sentiment is extremely negative. Domestic flows remain robust. Yet FPIs continue to sell. Why?

 

When I talk to peers across the world, the narrative is very similar. India is just too expensive. Even after the poor relative performance and multiple compression of the last 15 months, we trade at a 50 per cent premium to EM averages. Why pay 20 times for a market delivering only 10-15 per cent earnings growth? Why buy India when other markets like Korea or Taiwan have better earnings and are much cheaper? Indian return on equity is also no longer at a premium.

 

When asked why FPIs were so excited about India, especially at much higher valuations until just 18 months ago, what has changed? I get the following answers.

 

Prior to the last 24 months, India was to an extent the only game in town for EM investors. Six EM countries ( China, India, Taiwan, South Korea, Brazil and Saudi Arabia) accounted for almost 80 per cent of the index. China was considered not investable for geopolitical reasons, Taiwan carried China risk, Korea was a governance nightmare with poor capital allocation and Brazil and Saudi Arabia were seen as narrow commodity/banks plays. India was seen as the only large liquid EM with secular growth. India also had the surge in domestic flows, bringing in significant long-term captive capital into the markets. Indian multiples re-rated upwards, hitting a 100 per cent premium to EM averages at one point, but investors had limited alternatives. In a world of limited EM earnings growth, India’s ability to deliver a stable 15 per cent was very attractive. Indian markets were doing well, everyone bought into the secular growth thesis. Momentum was positive.

 

Today, the position is very different. China is investable, with some policy stability and global leadership across multiple industries. You cannot ignore China, given its strengths in the electric vehicle (EV) value chain, renewables, robotics and artificial intelligence (AI). Korea is still cheap and undergoing significant corporate governance reform, investors have seen the upside of this playbook in Japan. Taiwan with its leadership in semiconductors is unavoidable and even Brazil has its fans. India is no longer the only game in town. Therefore harder questions are being asked, both on valuations and longer-term growth prospects.

 

At its peak in September 2024, India was the most expensive market in the world. Valuation multiples reflect embedded expectations of growth, return on capital and the predictability and duration of that growth. Does India have the innovation capability and growth to justify these high multiples? The decline in multiples implies that investors are either reducing their growth expectations or the duration of growth.

 

Many investors feel that India is now stuck structurally at 10-15 per cent earnings growth. Large chunks of the market, information technology (IT) services, private banks, consumer staples, global generics are stuck at this level of earnings growth. Each sector has a different dynamic. Staples are seen as over earning, private banks face rejuvenated public sector bank competition, IT has the AI risk , and generics are moving to biosimilars. With the conventional sectors of the market stagnating and newer areas not adequately represented, how will market earnings accelerate?

 

Investor confidence on the duration of our growth has also suffered. There is not one key sunrise technology in which India has a significant market share. Investor perception is that we are not innovating. Even in our core strength areas of IT and pharmaceuticals, we are not seen as being at the cutting-edge in AI or biotechnology. Innovation is happening elsewhere.

 

Most investors also believe that we have not done enough on ease of business to attract manufacturing investment from multinational corporations (MNCs). The China-plus-one story has not played out at the speed investors anticipated. FDI flows continue to stagnate.

 

The worry on AI is that it fundamentally undercuts our main competitive advantage, viz. skilled white collar workers. If your business model is fundamentally based on selling billable human hours, it is under threat!

 

India continues to carry the perception that it is a difficult market to deal with, given tax and other regulatory hurdles. Investors will be more forgiving if returns are good. Today, these issues stand as negatives — why deal with the hassle?

 

Such is the FPI narrative today. While we are probably at peak negative India sentiment, and this sentiment has some element of cyclicality, with the AI trade front-loading earnings traction in North Asia, it is not entirely wrong. We need to regain the growth narrative. Today most investors see no compelling reason to look at India. Not cheap enough, not growing fast enough, not a global leader in any technology, why be here?

 

The government and companies have a role in changing this story. Industry can play its part by making bets in terms of capex and R&D; the government by improving the ease of doing business and addressing the policy and regulatory bottlenecks holding back our growth. Indian multiples expanded over the last few years, partly due to limited alternatives for global investors and partly due to belief in the secular growth prospects of the country. Both these factors have reversed. Where our valuations settle is anyone’s guess. An easier assertion to make is that we are unlikely to regain the valuation multiples of September 2024 anytime soon.

 

One should also guard against getting too negative. I sense peak negative sentiment on India today among global investors. It is a contrarian indicator. The argument that India cannot innovate or that our growth prospects have structurally dimmed is overstated to my mind.

The author is with Amansa Capital