The relentless march of FPIs to the exit gate

Source: This post is based on the article “The relentless march of FPIs to the exit gate” published in The Hindu on 5th Jul 22.

Syllabus: GS3 – Indian Economy

Relevance: Foreign Portfolio Investors (FPIs) exiting India, Impact of Russia-Ukraine war

News: FPIs have been on a selling spree in India. June 2022 witnessed the worst sell-off since March 2020 at ₹50,000 crore. This is the second highest sell-off in a month since 1993, after March 2020.

This comes on the back of May’s sell-off figures of about ₹44,000 crore. June was also the ninth on the trot that FPIs sold more than they had purchased.

Their selling actions have triggered a significant decline in benchmark indices, resulting in a drop in market capitalization of companies.

What are FPIs?

Foreign portfolio investors are those that invest funds in markets outside their home turf.

Their investments typically include equities, bonds and mutual funds.

They are generally not active shareholders and do not exert any control over the companies whose shares they hold.

The passive nature of their investment also allows them to enter or exit a stock at will and with ease.

What factors cause movement of the FPIs?

Promise of attractive returns on the back of economic growth draws investors, including FPIs into a country’s markets.

FPIs also show keenness to invest in bonds. This happens when there is a favourable differential between the real interest rates on offer in the country they aim to invest in, and other markets, but more specifically, the U.S.

Why have FPIs been selling India holdings?

Due to the following factors, there has been a decline in confidence of robust economic performance of India. This has led to the FPIs exiting market investments over these past months.

Uneven recovery: Post-pandemic, recovery in the Indian economy has been uneven.

– The second wave of the COVID-19 pandemic in 2021 devastated lives and livelihoods.

– The economy stuttered again when a third, albeit less severe, wave saw the spread of the Omicron variant early this year.

Add to this the return of pent-up demand in economies worldwide as the pandemic subsided.

The pace of recovery caught suppliers off guard, contributing to supply-side shortages.

Russia-Ukraine war: As the industry was grappling with supply-side shortages challenge, came Russia’s invasion of Ukraine.

– Sunflower and wheat supplies from these two nations were impacted, leading to a rise in global prices for these crops. As supplies in general tightened across the globe, commodity prices too rose and overall inflation accelerated.

Uncertainty of the industrial recovery: Industrial production has seen a bumpy ride without giving confidence of a full and final recovery from the pandemic.

– For example, the S&P Global India Manufacturing Purchasing Managers’ Index (PMI) slid to 53.9 in June — the lowest level in nine months — from 54.6 in the previous month.

Consumption expenditure too has remained weak in the subcontinent.

U.S. Federal Reserve raised the benchmark interest rate starting March this year, in its battle against surging inflation.

– When the differential between the interest rates in the U.S. and other markets narrow, and if such an occurrence is accompanied by the strengthening of the dollar, then the ability of investors to realise healthy returns is impacted. For returns are measured not only by the value appreciation of assets but also by exchange rate changes.

In such a situation, the FPIs tend to exit assets seen as ‘risky’ such as in emerging markets like India, Brazil or South Africa.

What impact does an FPI sell-off have?

When FPIs sell their holdings and repatriate funds back to their home markets, the value of local currency depreciates.

– After all, they sell rupees in exchange for their home market currency. As supply of the rupee in the market rises, its value declines.

The most telling impact is on the cost of India’s crude oil imports that contribute to 85% of its oil needs.