Stock markets of developing economies are generally prized possessions for Foreign Institutional Investors. It won’t be an understatement if you call FIIs the drivers and catalysts for the Indian stock markets too.
FIIs’ entry into the Indian markets can be traced back to 1992, and since then, FIIs have been supplementing domestic savings and augmenting investments. FIIs infuse the majority of volumes we witness in the broad market indices. Some of you must have heard market reports accrediting huge market volatility to FIIs’ selling and buying. FIIs are single-handedly capable of driving individual stocks and our benchmark indices– Nifty 50, Sensex, and BankNifty.
Before we assess the impact of FIIs on the Indian stock market in greater detail, let us cover the basics.
Who are FIIs?
Foreign Institutional investors, or FIIs, are firms that invest in the assets of countries other than the ones they are registered at. FIIs can be overseas pension funds, mutual funds, investment trusts, asset management companies, banks, institutional portfolio managers, charitable trusts, charitable societies, etc.
FIIs are generally given preferential tax treatment in most countries, including India. However, they are bound to comply with the regulations laid down by SEBI and the ceiling limits fixed by RBI.
According to the prescribed rules, FIIs are not allowed to hold more than 24% of the paid-up equity share capital of any Indian company. However, the same can be given effect if the board of the company receiving such investment passes a special resolution allowing the same. This ceiling is further dropped to 20% in the case of public sector banks in India. RBI foresees the compliance of this ceiling limit and sets a cut-off point of 2% below the maximum limit. It gives a warning to the Indian company if it receives the final 2% investment.
These regulations are laid down to limit the influence of FIIs on individual stocks and the financial market as a whole. But the question here is why these FIIs prefer investing their funds in India? Let us find out.
Why do FIIs prefer India?
FIIs are mostly based in countries with mature economies like the USA; there are no real growth opportunities in matured economies that can be translated into quick returns. Thus FIIs are always looking for growing economies with tremendous growth potential. Given the long-term growth prospects, India is arguably the most attractive spot for foreign institutional money.
Investors continue to be optimistic about India, and our Government is constantly trying to lure fresh foreign investors. The rate cuts brought into effect by the central bank favour FIIs as it infuses more liquidity into the markets. Moreover, India has well-regulated primary and secondary markets, making the investors confident about the security of their investment. To get into the details of the two kinds of markets, read our article on the difference between the primary and secondary markets on the Teji Mandi blog.
Why does the Government make such significant efforts to bring these FIIs into the Indian financial and economic ecosystem? Let us understand.
Why are FIIs relevant to the Indian stock market?
FIIs are investors with deep pockets of money looking for lucrative investment options. The amount of money they can invest is impossible to replace by domestic investors.
Moreover, markets move on institutional money, as institutions make up for most of the listed companies’ holdings and indices’ positions. For instance, during the first five months of 2022, FIIs have pulled out a whopping $22.5 billion from the Indian stock market; what has been the impact of this brutal sell-off?
Nifty had fallen close to 2000 points from its strike price since 1st January 2022. The same is the case with Banknifty and Sensex. Banknifty was down by more than 3200 points and Sensex by about 7000 points. This was when DIIs were net buyers; had DIIs not resorted to buying ways, the situation would have been even worse.
FIIs were all buyers in 2021 and invested over 50,000 crores in the Indian stock market. We all saw how welcoming it was for the market. All our indices bottomed out from lows due to the covid-19 pandemic and continued the bull run registering fresh lifetime highs.
Based on what we have explained, you can possibly conclude that FIIs have a major impact on the Indian stock market. Let us delve deeper into this discussion.
How do FIIs impact the Indian stock market?
Role in Indian economy
FIIs come from capital-intensive economies with an abundance of cash reserves. Though their primary aim is to generate returns on their capital employed, they catalyze several activities in the process.
They create new business opportunities, generating employment that our labour-intensive economy is always in need of.
FIIs encourage exports, which brings the much-needed foreign reserves to the country, thereby reducing current account deficits in the external balance of payments. They also provide:
- A viable alternative to foreign debt.
- Bring in new edge technology.
- Create a competitive marketplace, and
- Improving the capital structure with their equity inflows.
History of FIIs in the Indian stock market
FIIs were net buyers for five straight years since they were allowed to invest in Indian stock markets in 1992. Since then, the amount of FIIs inflows only grew in numbers. Rs. 79,709 crores in 2013-14, Rs. 1,11,333 crores in 2014-15, and Rs. 1,19,036 in 2017-18 were some of the years when FIIs bought aggressively.
However, whenever there’s a big crisis on the world forum, FIIs tend to rush out of Indian markets. Examples of this are the 1998-99 Asian currency crisis and the Lehman Brothers crisis in 2008-09. During the Lehman crisis, FIIs were the real culprits behind making things look ugly for the Indian stock market as they pulled out Rs. 47,706 crores from India.
The huge file sell-off since October 2021
There’s only one question across the stock market in India: When will FIIs turn into net buyers again?
Initially, the selling from FIIs was considered a profit booking. However, even FIIs have cashed out all their investments before the onset of the covid-19 pandemic. The selling is relentless and doesn’t seem to stop anytime soon. FIIs are largely speculative and take a short-term view, and thus are more volatile than other forms of capital.
FIIs can be seen as’ fair weather friends’ in the context of the Indian stock market as they come in volumes when there are opportunities for making money and leave with the first signs of a slowdown. These large withdrawals and marginal portfolio adjustments can bring economic instability to the country. However, DIIshave thus far tried to negate the intense selling pressure coming from FIIs.
Let’s understand the reasons for such a large-scale sell-off.
Reasons for selling pressures from FIIs
FIIs may put an intense selling pressure due to the following reasons:
Inflation worries around the globe
Inflation in America and Europe has touched its 40-year high. Soaring costs of food, gasoline, and other housing necessities are squeezing the liquidity. High inflation has pushed economies to raise interest rates, and liquidity gets a hard hit with each rate hike. Also, bond yields are constantly increasing, and when bond yields are promising, FIIs tend to pull out their equity investments and invest in debt securities.
Soaring crude oil prices
Despite being miles away from Russia and Ukraine, India could feel the heat of the war out there. Being the third-largest importer of crude oil, the rising crude prices are contributing to the rising inflation in the country. Investors don’t like uncertainty; when there are inflation clouds, FIIs would undoubtedly like to sit on cash rather than undertaking risky investments.
To understand the impact of crude oil in greater detail, read our article on ‘how does crude oil price impact the stock market‘ on the Teji Mandi blog.
Since the post-covid recovery, Indian markets never looked back; when markets clung to record highs, the valuations were pretty expensive. The price-to-earning (P/E) ratio of Sensex was 31 times, and that of Nifty was around 28.17 times. The same was the case with stocks; riding the unprecedented covid rally, stocks were trading at expensive P/E multiples. Valuations beyond the buying range could also be considered a trigger for such systematic pullout by FIIs.
FIIs bring dollars, convert them into the Indian rupee and invest in the Indian stock market. But when they cash out, they convert the rupee into dollars, and since the rupee value is on a decline, they get fewer dollars in return.
For example, suppose FIIs invested $100 in India and made 12% returns in a year. However, the rupee also depreciated by 3% in the same period, limiting the net profits that FIIs take away to 9%.
Now that we have looked at the FII activity in India over the years, let us see what the future expectations from them are.
What are the future expectations from FIIs?
The majority of the factors pushing FIIs into selling are short-lived. The market would soon factor in the interest rate hikes, and the valuations will ultimately come to a reasonable range. The Russia-Ukraine war will ultimately come to an end. Crude prices will cool down. Thus, it’s not that FIIs will continue to sell for eternity. They cannot sit on their cash reserves for long. India is still the most appealing market in terms of growth. The GDP projections for the financial year 2022-22 are at 17.2%, which, by all means, is a huge positive. Government plans its CAPEX at 27% and has already introduced several sector-specific PLI schemes. FIIs would not be willing to miss out on any growth opportunities in India, especially now when the markets have corrected significantly from all-time highs. One can expect FIIs to turn back to buying once the temporary volatility in their home markets due to interest rate hikes is over.
FIIs positively impact the financial markets and tend to drive the major trends in the Indian stock market. Of the three market players, i.e. the FIIs, the DIIs and the retailers, FIIs are clearly in a position to lead the rally in the direction they decide, given their quantum of investment.
As retail investors, though we cannot predict the next move of FIIs, it’s best to keep track of what FIIs are doing. Because the broad market indices will ultimately follow the FIIs as they have all the money to drive markets, you can refer to daily updates SEBI releases on FII and DII activity during the trading session. To get all the latest updates from the market right on your phone, you can download the Teji Mandi app. To get active investing advice, reach out to our experts through our website.