FPI inflows moderate to ₹7,320 crore in August, debt market investment steady: 5 key factors behind sell-off

Foreign portfolio investors (FPIs) continued their three-month streak in Indian equities, but inflows moderated in August, driven by domestic and global factors. However, they were consistent buyers in June and July after election-related jitters faded and stability returned to Indian markets. However, FPIs halted their buying streak with the onset of the new fiscal year 2024-25 (FY25).

FPIs invested ₹7,320 crore worth of Indian equities, and the net investment stood at ₹25,493 crore as of August 30, taking into account debt, hybrid, debt-VRR, and equities, according to the National Securities Depository Ltd (NSDL) data. The total investment in debt markets stood at ₹17,960 crore in August.

Also Read: Independence Day 2024 | FPIs pumped ₹64,824 crore in Indian equities over 12 months: 5 key reasons behind inflows

"FPI investment in equity is steadily coming down recently with net investment of only ₹7,320 crore in August compared to ₹32,365 crore in July. Bulk of the buying that FPIs are doing are through the ‘primary market and others’ category. They have been consistent sellers in the cash market because of the elevated valuations,'' said Dr V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.
 

What's fuelling the sell-off from FPIs in Indian markets?
 

1.High valuation of the Indian stock market

According to Geojit's Dr Dr. V K Vijayakumar, the fundamental reason for the poor FPI interest is the high valuation in the Indian market. ‘’With Nifty now trading at above 20 times estimated FY 25 earnings, India is the most expensive market in the world. FPIs have opportunities to invest in cheaper markets, so their priority is markets other than India,'' he said.

Vaibhav Porwal, Co-founder, Dezerv agreed. "Valuations in the Indian equity market have risen to relatively high levels, leading FIIs to exercise caution when investing in India. They have been selectively investing in defensive market segments, focusing on sectors such as healthcare and FMCG,'' said Porwal.

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Market analysts reiterated that the FPIs have been involved in mixed activity recently, with bouts of buying and selling, a trend that will likely continue for some time. ‘’FPIs have been selling in the secondary market, where valuations are perceived to be high, and redirecting their investments towards the primary market, which offers relatively lower valuations,'' said Vipul Bhowar, Director Listed Investments, Waterfield Advisors.

2.Unwinding of Yen

According to Vipul Bhowar of Waterfield Advisors, the unwinding of the Yen carry trade on August 24 significantly impacted FPI behaviour, leading to substantial selloffs in Indian equities. In response to Bank of Japan Governor Kazuo Ueda's hawkish tone at the July monetary policy meeting, speculators unwound their yen carry trades, pushing the yen stronger. The term refers to borrowing Japan's cheap currency to invest in countries offering higher yields.

3.US Fed rate cut bets

‘’The unwinding of Yen coincided with rising fears of a potential recession in the U.S. and disappointing economic data, which further exacerbated the market's reaction,'' said Bhowar of Waterfield.

US Federal Reserve Chairman Jerome Powell’s statement at Jackson Hole signalling imminent rate cuts and greater confidence in a soft landing helped prop up emerging markets, including India. Market analysts say FPI flows are expected to remain volatile due to high rate-cut bets.

‘’The US Fed is expected to start its rate-cut cycle in September. Historically, rate-cut cycles in the US market have not been favourable for their equity markets. We anticipate that FIIs will shift their focus to emerging markets, deploying capital where valuations are more appealing. However, India may not be a significant beneficiary of these flows,'' said Vaibhav Porwal of Dezerv.

4.Tax changes announced in Union Budget 2024

Market analysts said the spike in the capital gains tax and the removal of the indexation benefit were a few factors that resulted in a higher tax burden for investors. Another factor was a hike in the securities transaction tax (STT) rate for FnO trades, which will impact liquidity and make hedging costlier.

’'FPIs may opt to prioritise sectors that benefit from domestic reforms and growth, such as technology and infrastructure, while approaching sectors vulnerable to global economic downturns with prudence,'' said Bhowar.

5. Shift to debt instruments

According to Geojit's Dr. V K Vijayakumar, FPIs are buying in the debt market mainly because the INR has been stable this year, and this is expected to continue. ‘’On the debt market front, the strong buying trend among FIIs can be traced back to India’s addition to JP Morgan’s Emerging Market government bond indices earlier this June,'' said Vaibhav Porwal of Dezerv.

Analysts added that the recent announcement of increased capital gains tax on equity investments has also prompted foreign portfolio investors to sell off their holdings, shifting funds towards safer debt instruments.

‘’The inclusion in global bond indices, attractive interest rates, stable economic growth, shift from equities, and favourable long-term outlook have been the key factors driving FPIs to invest in debt,'' said Vipul Bhowar of Waterfield Advisors.
 

Also Read: FPIs sell-off rises to ₹21,201 crore in India equities on domestic, global factors; When will inflows resume?
 

When will FPI inflows resume?

Analysts say the selling trend is likely to continue since India is the most expensive market in the world now, and “it is rational for FPIs” to sell here and move the money to cheaper markets. "This picture doesn’t change even if the market turns more bullish on fears regarding US recession receding,'' said Dr. V K Vijayakumar.

"While September is likely to see continued interest from FPIs, the flows would be shaped by a combination of domestic political stability, economic indicators, global interest rate movements, market valuations, sectoral preferences, and the attractiveness of the debt market,'' said Vipul Bhowar of Waterfield Advisors.

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