The Cyclical Trend of FII Selling

There is no doubt that since the early 1990s, economic and financial liberalisation have transformed India's stock markets. Sensex, which remained below 5,000 for much of the 1990s, crossed 20,000 in 2008, 25,000 in 2016, and then it touched 60,000 in 2022 with an associated increase in market capitalization. These increases have been largely attributed to capital invested by foreign institutional investors (FIIs), along with investments from domestic financial institutions, corporations, and high net worth individuals, which have contributed to increases in market indices and capitalisation.

Indian equity markets have been witnessing a lot of turbulence for quite some time due to heavy Foreign Institutional Investors (FII) selling across all sectors. It is continued and compounded with weak global cues due to the resurgence of another member of COVID clan and adoption of stricter monetary policies by central banks all over the globe to curb rising inflation.

Fed Policy Changes Impact

FIIs have turned net sellers this fiscal, selling stocks worth almost Rs. 45,000 crore whereas they had net purchased stocks worth Rs. 2,75,000 crore last year. They have been selling every month since September 2021, pulling out $7.9 billion worth of local shares. This four-month streak of withdrawals is set to be the longest since January 2017.

Concerns that the Federal Reserve will tighten monetary policy more than expected has intensified the recent equity selloff. Overseas funds have sold more than $3 billion of Indian shares this month alone, according to the latest available data.

As the Federal Reserve has recently stated, it not only intends to raise interest rates soon, but to remove the surplus liquidity that was fueling the asset price boom in global markets. There will soon be a change in policy rates in the US; Fed Chairman Jerome Powell has indicated an increase will be appropriate due to sustained job growth and sticky inflation, which has remained higher and longer than originally anticipated. While Powell said that the rate action depends on incoming data, it is quite likely that the rate hike cycle will begin during the first quarter of the year. It is also possible for the first rate-hikes to be aggressive to curb inflation.

Other major policy moves that will affect global financial markets include the Fed's plan to cease net asset purchases in early March and begin shrinking its balance sheet as soon as policy rates are raised. This action will drain financial system liquidity.

In response to this, MSCI World Equity Index has declined 7% this month as investors pull funds out of overheated stocks worldwide.

As the world braces for the rate hike cycle to begin in the US, sovereign bonds are also rising across the globe. Institutional investors have begun moving funds out of risky assets such as emerging market equity, bonds and cryptocurrencies and into dollar denominated assets as safe havens. Consequently, currencies of emerging economies are weakening, further accelerating fund outflows.

Limited Impact on Indian Indices

It is evident that FIIs have been selling heavily in Indian stock markets. They have sold more than $3 billion in January alone in the cash segment till January 28th, as per official data. In the last 4 months including January FPIs selling stood at almost $9 billion. But the Sensex and Nifty have fallen just 8% in this period.

As per NSE data, FIIs have sold $7.24 billion between Oct 1 and Jan 25, but there has been buying of $9.63 billion by domestic investors. Majority of inflow is from retail investors. The data from Economic Survey 2022 shows that share of individual investors in total NSE turnover increases to 44.7%. This is spurred by robust growth in UPI and tech-savviness of investors.

In most cases, retail investors would prefer investing in the IPO market due to overpriced and hard-to-get stocks in the secondary market. It is also important to note that the latter stocks are from companies whose history has been reviewed and their performance has been analyzed. As a result, these stocks may be seen as stocks with levelled prices and few opportunities to gain capital. On the other hand, new equity issues do.

This is the reason primary markets are buzzing and many IPOs are getting oversubscribed. The year 2021 has been a period of remarkable growth for the Indian primary market with 63 companies collectively raising Rs 1.2 lakh crore through initial public offerings which is the highest amount ever raised in a single calendar year.

SIPs are a popular mode of investment among retail investors. Data from AMFI shows that the amount invested in mutual funds surged to $4.38 billion through SIPs in the last quarter of 2021. This was 40% higher than the previous year.

Direct investments and mutual funds are reducing the dominance of FIIs because retail investors are increasing. Unlike earlier, where only LIC used to act as a counter balancing agent for FII selling, the market is also supported by EPFO, NPS, and ever-growing retail investors.

Domestic support has limited the overall impact of FII selling, except for FII-concentrated stocks which are adversely affected.?

The trend in a graph above shows the cyclical nature of FIIs interest. Besides, this also indicates even FIIs adopt selectively and do a sector rotation strategy. There is a cycle of FII inflow and outflow. Which means the current robust outflows will be compensated by huge inflows in coming time.?