FIIS Are Here To Stay

As goes January, so goes the year. This is one of the most cited cliches used in the stock market to predict the course of the rest of the year. But when it comes to the investment trends of FIIs in India, this adage does not hold. FIIs, being one of the most potent forces that give direction to the Indian equity market, have witnessed net investments in the negative in the month of January during the last three consecutive years and yet at the end of the year the total FII investment has remained positive. It was only the year 2008 which was an exception in more ways than one when FII investments remained in the negative even at the end of the year. 

Moreover, this is not the first time that FIIs have had a negative flow in the month of January. If we take into account the average investment by FIIs over the last 11 years for the month of January, it works out to be USD 121 million of outflows. Therefore we can safely assume that the year 2010 will also remain one of those years when FIIs will be pouring money into the Indian stock market once again despite taking away USD 94.51 million in January 2010. And the trend already seems to have been reversed with the inflow of USD 269.88 million in the month of February 2010. However, before coming to a conclusion of why FII investment will remain positive in 2010, let us scratch the surface a little more and study the trend of FII investments in India and how they have given our markets a direction.
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We analysed such movements across 143 months starting from April 1998 and found that February and March remain the best months for investment by FIIs. In 11 years starting from 1999 we found that only once has there been any negative FII inflow. Even in 2008 when FIIs altogether withdrew Rs 53,000 crore or USD 11.3 billion, they invested USD 1.05 billion in February 2008 which somewhat arrested the free fall of the Sensex in February 2008. Even in terms of median investment, February remains one of the best months with median investments by FIIs to the tune of USD 587 million.
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Similarly, in the month of March there has been only one instance in the last 12 years when there wasnegative FII inflow. Even last year, after selling in the months of January and February, FIIs started reinvesting from the month of March.Now let us check out the months that have remained unfavourable in terms of investment for FIIs. Clearly it is the month of May which is ahead of the other 11 months. In the last 12 years FIIs withdrew money from the Indian markets six times in the month of May whereas they poured it in a similar number of times. Other months that followed are June and October wherein there have been negative outflows five times each. But when we talk in terms of years, 2008 remained the worst year and 2009 the best year for investments by FIIs. These are the also years which hap-pen to be one of the worst and best years for market returns respectively. In 2009 the Indian bellwether index was up by 79.6 per cent, highest in 17 years.

So is this an aberration of sorts that the highest FIIs inflow is accompanied by highest market returns? We do not feel so and it seems that the Indian stock market is a slave to FII investments. In the last 142 months there have been only eight instances when despite negative FII inflows the market went up. But in most cases it was less than one per cent and it was the de-coupling theory just before the collapse of Lehman Brothers that led to market exuberance. Its true impact was demonstrated in the month of October 2008, when the market fell by 25 per cent, highest in one single month with FIIs withdrawing USD 3.8 billion, once again the largest withdrawal by FIIs.

Now that the importance of FIIs to the Indian equity market is established, we will try to understand if they will reverse their course of action in the remaining months of 2010. One of the reasons for such high FIIs inflow in 2009 was the huge liquidity in the system due to the central banks around the world doling out rescue packages to help their economies to cope with one of the worst economic crisis since the Great Depression of 1930. With developed economics still to demonstrate sustained economic revival, we feel that the interest rate will remain low and that will help the FIIs to remain invested in emerging economics. This is further reiterated by the fact that the FOMC (Federal Open Market Committee), in its meeting held on March 16, has left the rate unchanged at 0-0.25 per cent.
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Moreover, we believe that the recent outflow (as in January) was just part of a defensive strategy to shift some of their funds to safer dollar-denominated assets in the wake of the recent credit turmoil in Europe. The other factors that make the Indian market attractive for FIIs include its strong internal consumption story and a higher sustainable growth rate. Most of the investors will be paying a premium for the differential growth compared to absolute growth. Further, higher valuation concerns such as higher PE or book value are only for a few of the stocks representing the indices.

There is a lot of opportunity in stocks outside the indices and with the Indian equity market boasting of one of the largest and most diversified scrips to pick, this represents many opportunities for FIIs to make a decent return on their investments. Therefore, despite 2010 entering at higher valuations than at the start 2009, we believe that FIIs will remain invested in the Indian market and will increase their exposure in the coming months.