FII flows – Not so Fickle in the Longterm !!!

Perceptions are powerful , yet rarely reflect the reality in much of the cases  . While this is generally so , the divergence is strikingly stark in the case of FII flows . The perception that the FII equity flows are hot and hostile couldn’t be more contentious . On the surface , the flows look deceptively volatile and hot  . Underneath , however , deeper trends are at play  that makes equity flows more loyal historically to India story.

Bit of number crunching can clear the clogging at the surface . Looking at the  last ten years data , from calendar year 2004 to 2013 ,  FII equity flows have been positive all thro’ this period with the sole exception of 2008 which saw one of the worst financial crisis globally post Lehman accident . Same is the case with Debt FII flows except that the calendar year 13 saw sharp outflows ( see below exhibits)   leading to brutal volatility in Rupee and bond yields  .

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  • Both these charts are powerfully illustrative on the close link between the Fed easing and the quantum of India flows . Both equity and debt flows saw a sharp spurt from 2009 as Fed started the monetary easing program by cutting rates and by buying bonds ( Quantitative Easing) .       
  • The reason for remarkable stability that Rupee enjoyed ( in spite of huge current account (CAD) and fiscal deficits ) till early 2013 can be traced to the quantum leap in fund flows between 2009 and early 2013  .
  • However , debt flows from FIIs have not been that charitable in year 2013 starting from June  . On Fed’s tapering noise , FIIs pulled out massive 10Bn+ from debt funds from June  this  year  resulting in mayhem in bond   and    currency markets . Ten year yield jumped sharply beyond 9%+ and Rupee saw one of its worst fall to 68 level ,later recovering to 62 level on RBI’s supporting measures and intervention.
  • In the same period ( Aug –Sep this year) when India saw one of the worst mini financial crisis , equity flows have been more even ( marginally positive) supporting the view that much of equity flows is  of  long-term in nature and can be relied upon as a dependable funding source .

This is not to deny that the certain composition ( short-term money) of equity flows is indeed hot and vulnerable to quick exits . However , such composition is not overwhelming going by this historical data and as a result , lending some credibility to the dependability of these flows .

As we reflect these data points , it may be fair to summarize that  FII equity flows ( debt flows to a lesser extent)  have been lot more sticky and hence loyal to India  , negative perception notwithstanding  . It is time that policy makers and administration recognize this loyalty and reward them with friendly reforms and policy measures that support and enhance the long-term component of such flows .

Market View :

There is a growing view amongst investment community that the market has gradually started discounting positive political formation in the center in the upcoming lok-sabha election . This view is emerging stronger among FII community in particular leading to stronger rally in Indian markets . FIIs have turned over-weight  on India and this is reflected in sharp jump in FII flows in the last 3 months ( exceeding 5 Bn+ in this period). While this view may be premature , there is no denying that the market is looking forward to changing political dynamics with growing optimism .

Further , there is emerging consensus now that the GDP growth will come back in FY15 plainly on account of base effect and on the fact that  the worst is  behind us , not by any radical structural change . But , for that growth to get accelerated further , market needs a growth trigger in the form of stable political formation , visibility of which seem to be improving as the days go by.

This does not mean everything is rosy for the market now . US debt ceiling crisis , Fed tapering risks etc have not gone away . They will come back to haunt us in next few months during which time , market will turn volatile once again . Longer term investors should use every such opportunities to build and structure their portfolios for the eventual turn in the tide .

ArunaGiri . N