Net FII inflows set to hit a record high in FY15

Mumbai: Foreign institutional investors’ (FIIs) net investments in Indian equities and debt are set to touch a record this financial year, backed by expectations of an economic recovery, falling interest rates and improving earnings outlook, but some are sceptical if these inflows will continue at the same pace.

FIIs have invested a net of $43.5 billion so far in 2014-15— expected to be their highest investment in any fiscal year. Of this, a huge chunk—$26.3 billion—was invested in debt and it is their record investment in the asset class, while equities absorbed $17.2 billion.

BSE’s benchmark Sensex has already risen 29.2% so far in fiscal year 2015, and if this sustains, it would be its best performance since financial year 2010.

According to data from Bloomberg, Indian debt has been the third-highest recipient of foreign fund inflows in the current financial year after Japan and South Korea in the Asia-Pacific region ex-China, and has received the highest such inflows into its equities in the region.

China does not release exact data of foreign inflows.

One of the reasons why foreign investors put money into Indian bonds is to take advantage of the yield differential between India and developed markets such as the US.

“The debt flows have been running strong due to existing high interest rate arbitrage, and people had a positive view on the currency,” said Dhananjay Sinha, head of research at Emkay Global Financial Services Ltd, adding that the positive sentiment with respect to fiscal deficit and credit rating were also adding to the strong interest.

“All that put together gave them a good arbitrage opportunity in interest rates,” Sinha said, adding by and large, FII limits for government securities has been exhausted and the limits for some corporate debt have also been utilized.

“However, as we get into 2015, US interest rates are expected to rise and Indian rates are expected to fall, which means that these yield differentials will narrow. That may have some negative impact on flows into the Indian debt markets.”

According to data on the National Securities Depository Ltd (NSDL) website, FIIs have exhausted more than 99% of their total $30 billion investment limit in government securities.

In the corporate bond market, 74% of the total limit has been exhausted and no fresh investments are allowed in the short term commercial paper segment, according to the NSDL website.

“The prime reason for the strong inflows in debt is the interest rate trajectory in India. We have already seen a 50 basis points (bps) cut and we will see more in days to come. Apart from yields, it is more about pricing of bonds. FIIs tend to gain on mark to market and in terms of capital gains,” said Vaibhav Sanghavi, managing director of Ambit Investment Advisors Pvt. Ltd.

“Also, India has been a relatively stable currency compared with other emerging markets; and that makes it attractive to invest in Indian debt,” added Sanghavi.

The Indian rupee has fallen a mere 4.9% in fiscal year 2015, compared with a 30.1% decline in Brazil’s real and a 43.5% fall in Russian rouble.

Sanghavi. who expects interest rate cuts 75-100 basis points between now and the end of FY16, expects the flows are likely to continue. But the fact that FIIs’ limits to invest in government securities was exhausted could act as a hitch, he said.

One basis point is one-hundredth of a percentage point.

Inflows into equities were backed by strong expectations that the Narendra Modi government that took charge in May could turn around the sluggish economy and steer it to a strong growth path.

“It’s a long-term story. India is one of the best placed emerging markets in terms of improving economic fundamentals. On a relative scale, India is going to attract continuous flows and going to be a preferred destination,” said Sanghavi of Ambit.

According to the Economic Survey released on 27 February, Asia’s third-largest economy is set to grow by 8.1-8.5% in 2015-16, up from an estimated 7.4% in the financial year ending on 31 March, and accelerate to a double-digit pace in a couple of years.

The estimates are based on a revised way of calculating gross domestic product adopted recently by the government’s statistical arm.

Sinha of Emkay pointed out that the investments in equities picked up around May, after the general election brought the National Democratic Alliance (NDA) to power.

Expectations that the new government’s strong mandate will help it revive investments and boost earnings prompted investors to put their money into equities.

However, corporate earnings have not really matched the heightened expectations.

“Earnings turnaround has not happened and it has fallen short of expectations. Nifty has given around 5-5.5% earnings growth this year, compared to expectations of close to 17-18%—and earnings downgrade is imperative,” pointed out Sinha.

“FIIs have been overallocating to India. If Fed increases rates in the second half of the year. We could see volatility in flows, and some outflows could be inevitable,” said Sinha.

Disclaimer: This information has been collected through secondary research and IBEF is not responsible for any errors in the same.