Year 2018 was not good for the Indian markets in terms of foreign portfolio investment with net outflows of Rs 34,163 crore, the second-highest since 2008, the year of the global financial crisis. The reasons for the decline are not surprising — valuations had turned expensive in the first quarter of 2018, and the US Federal Reserve was taking a hawkish stand and was on a rate hike cycle till January 2019. In March, it turned decisively dovish ending three years of tight money policy as US economic growth was slowing. Since then the rupee has gained and emerging markets, including India, which had seen money being pulled out, have seen a reversal. India has become the largest recipient of FPI flows in emerging markets since February 2019 with net equity investment of $8.3 billion, which coincides with the change in the Fed stance.
After nearly a year of see-saw, the Indian markets may not be looking as expensive as they did in early 2018 and hence global portfolio investors are turning aggressive. Expectations of better macros, corporate earnings growth and the domestic consumption story have put India on the FPIs’ buy list once again. A stable rupee and benign inflation are also positives. However, the concern in the minds of domestic players is that the flows so far are more due to a risk-on trade driven by liquidity after the Fed’s brake on rates, which will be followed by a similar action by other global central banks, or whether it is due to fundamentals. The spread between India’s earnings yield and the US 10-year bond yield, which has typically averaged 3.9 per cent, is still below 2.9 per cent. A higher spread would make a foreign investor more comfortable in terms of valuation.
The Sensex has gained 7.4 per cent since February, given the gush of money that has come in. The question is whether the FII flows will sustain, given the fact that they have cooled off a bit over the last week. There are reasons for this concern: The market appears expensive at current levels given that earnings growth has been disappointing in the past few years; moreover, a below normal monsoon forecast does not augur well. Any negative surprise in March quarter results or crude oil prices could lead to a correction. Besides these, foreign money flows will also depend a lot on the new government’s policies. More reforms are needed in land and labour, and investors will be watching how the new government, which will take office in May, steps up economic growth and revives business confidence. While capacity utilisation in manufacturing is at a multi-year high, businesses will need more confidence before putting up plants, which is necessary to revive the capital expenditure cycle. The return of foreign investors is obviously a good sign for the Indian economy, but policymakers must be careful not to take them for granted.
 "Illustration: Binay Sinha")