Navigating the Current Stock Market Landscape Amidst FII Outflows

The Indian stock market is currently in a phase where positive news seem to have little impact on investor sentiment. Despite favourable developments such as the Reserve Bank of India’s recent rate cut—the first in two years—and a substantial Income Tax reduction aimed at boosting consumption by approximately ₹1 lakh crore, the markets have remained largely unresponsive. Additionally, the RBI’s decision to lower the risk weightage for non-banking financial companies (NBFCs) from 125 per cent to 100 per cent – a move beneficial to the financial sector – has not led to an anticipated market uplift. 

This suggests that market sentiment remains weak and is not favouring bullish trends. One of the major reasons behind this sluggish performance is the persistent selling by foreign institutional investors (FIIs). Over the past five months, FIIs have offloaded approximately USD 37 billion worth of domestic shares. This substantial outflow has coincided with a nearly 20 per cent decline in the NSE Nifty 50 index in dollar terms and a 13.5 per cent drop in absolute terms, while the broader indices have suffered even more. 

The selling spree by FIIs can be attributed to multiple factors. First, attractive US bond yields hovering around 4.5 per cent offer a compelling alternative to emerging market equities, drawing capital away from India. Second, the Indian rupee has depreciated by 3-4 per cent, reducing dollar returns for foreign investors. Additionally, the 2.5 per cent increase in long-term capital gains tax further diminishes returns for foreign investors. Lastly, an earnings slowdown coupled with high valuations makes the Indian market less attractive compared to other investment avenues. 

Historical trends from previous cycles, such as those in 2008 and 2022, suggest that FIIs could sell up to 1 per cent of India’s total market capitalisation, translating to around 5-5.5 per cent of their peak holdings. With India’s peak market capitalisation at approximately ₹450 lakh crore and FII holdings at around ₹80 lakh crore, this could mean selling pressure of ₹4-4.5 lakh crore. Since FIIs have already offloaded around ₹3 lakh crore, the remaining potential selling could be in the range of ₹1-1.5 lakh crore. 

On the domestic front, domestic institutional investors (DIIs) have been a stabilising force. With monthly inflows through SIP of around ₹26,000 crore, translating to annual inflows of over Rs three lakh crore, DIIs have provided the much-needed support against FII outflows. Investments by EPFO through Exchange-Traded Funds (ETFs), Life Insurance Corporation (LIC), and other insurance companies contribute another ₹50,000 crore annually, while existing cash holdings of institutions of around of ₹1-1.5 lakh crore offer an additional cushion. Although DII inflows may not entirely offset FII selling, they help soften the impact, ensuring that the market’s decline is more gradual rather than steep.

Overall, while the Indian market continues to benefit from strong domestic consumption and supportive government policies, global uncertainties and persistent FII outflows are likely to keep it in a consolidation phase. A sustained rally appears unlikely in the near term, but a sharp correction is also not expected as the overall market is already down by around 20 per cent from its peak. Sector rotation is likely to continue, with cyclical stocks outperforming defensive ones in the coming months. The road ahead may be bumpy, but with the right strategy, the destination remains promising.

RAJESH V PADODE
Managing Director & Editor