Vijay Kumar Gaba: FPI

Showing posts with label FPI. Show all posts

Saturday, December 4, 2021

Are Foreign Portfolio Investors (FPIs) dumping Indian securities?

The media headlines are implying that the foreign investors have been incessantly dumping Indian equities; and this could be one of the primary reasons for currently ongoing correction in the equity prices.

Though there is no evidence of any strong correlation between Nifty and foreign flows over medium to long term (3 months and beyond); these flows have been seen increasing the volatility in near term.

In particular, if the correction in prices is sharper, the selling by foreign investors is highlighted prominently, adding to the nervousness of the non-institutional investors. It is therefore important to know the actual trend of foreign flows; and analyze whether the selling is part of any structural change in their view or just a trading tactics to enhance their return.

The market participants, who track the daily foreign flows closely and get influenced by the provisional net flow data released by SEBI every evening, must note that—

· “Foreign portfolio investors” (FPIs or FIIs) is not a uniform class of investors. This includes a variety of overseas investing entities with divergent investment objective, horizon, and strategies. These include, pension funds having a very long term horizon; hedge funds and alternative investment funds with short term investment horizon; dedicated India funds which raise money from individual investors for investing in India only; emerging market funds which invest in all emerging markets including India; ETFs which track benchmarks like MSCI Emerging Market Index; MSCI India Index; iShare Asia ETF; iShare EM Dividend ETF etc.

All these overseas investing entities usually do not act in unison and mostly have different approaches to investment. Their universe of stocks to invest could also be different.

· The provisional data of FPI net flows, released everyday evening by SEBI does not represent the actual net FPI flows into India. This is just provisional data of net flows into secondary markets as reported by the custodians to SEBI. The real net flows include investment in primary market and debt securities also.

· Many FPIs just run an arbitrage or long short book. They take self-cancelling positions in equities of various regions (e.g., Europe vs Asia), categories (e.g., emerging vs developed), countries (e.g., ndia vs Indonesia) or segments (e.g., cash vs derivative) to take advantage of short term trading opportunities. Their positioning usually does not reflect their fundamental view on a country, region, or category.

· Forex rates could be an important consideration in many FPIs’ investing strategy. Thus, many a times net foreign flows could be influenced by FPIs view on INR exchange rate rather than the equity valuations.

· Selling by FPIs does not necessarily mean outflow from the country. Many times, it is just an asset allocation call between equity and debt; a short term tactical trade; or sale in secondary market to buy in primary market.

An analysis of the trend in FPIs flows for past 10years, and in particular, since the first lockdown (March 2020) due to Covid-19 pandemic, highlights that FPIs have remained consistently positive on India. Despite multiple downgrades of Indian equities by global brokerages like Morgan Stanley, CLSA, Credit Suisse, Goldman Sachs etc., no significant selling has been seen so far. Though, on relative basis the flows to India as compared to other emerging markets might have slowed in past few months.

It is pertinent to note that the sovereign rating upgrade by the global rating agency Moody’s a few months earlier also did not have any noticeable impact on the foreign flows into Indian securities – equity or debt.

In fact, the domestic institutions have invested significantly lower amount in Indian equities in past 10yrs as well as during the period since March 2020, as compared to the net flows of foreign investors.

The following are the key data relating to the foreign and domestic flows:

FPIs’ risk reward is different from Indian investors

In past one decade, Nifty 50 has yielded a return of 215% in INR terms. However, USD denominated Nifty 50 has returned less than half (~106%). The USDINR exchange rate has deteriorated from Rs53/USD in December 2011 to Rs75/USD presently. The yearly average exchange rate of USDINR in past 10years has been Rs66.7/USD. The risk reward of overseas (USD) investors there is very different from Indian (INR) investors. They have to manage the currency risk, in addition to the market and business risks of Indian equities.

FPIs investment in Indian equities consistently more than DIIs

In past 10years, the net investment of overseas investing entities has been mostly higher than the investment made by domestic institutions. Even during the Covid period (since March 2020) FPIs have invested more than the domestic institutions.

In past 10yrs, FPIs have invested a net amount of Rs7.15trn in Indian equities, as compared to Rs2.07trn investment made by domestic institutions. Since March 2020, FPIs have invested a net amount of Rs2.08trn in Indian equities, as compared to Rs26.6bn net investment by domestic institutions.

40% of FPI equity investments are in primary market

Over past 10years, FPIs have net invested Rs7.15trn in Indian equities. Out of this, Rs2.92trn has been invested in primary market and the balance Rs4.23trn in secondary market. On net basis, FPIs’ flow have been negative only once in 2018. However, if we consider secondary market alone, FPIs have been net sellers in 3 out of past 10 years, i.e. 2015, 2018 and 2021.

FPIs sold Indian debt in 2021 despite rating upgrade

FPIs have invested Rs1.69trn in Indian debt securities in past 10years. Since March 2020, they have net sold Rs921bn worth of Indian debt.

The lower FPI investment in debt, despite high yield differential with developed markets, could be a matter of concern. Lower rating and lower FPIs quota in government securities could have been couple of many reasons for the low interest in Indian debt. However, even a rating upgrade few months ago and materially increase in quota during past few years has not resulted in flows into Indian debt securities.

Interestingly, FPIs have been net sellers of Indian debt in 5 out past 10 years.

FPI flows and Nifty poorly correlated

As mentioned above, FPI net investment is significantly larger than the domestic institutions’ net investment in Indian equities. However, there is little evidence to indicate that FPI flows materially influence the market direction over a longer period. Even on monthly basis the correlation between FPI flows and volatility is poor.

Conclusion

FPIs are not a uniform class of investors. However, collectively they have been positive on Indian equities for long. There is no evidence to indicate that they are dumping Indian equities or causing unusual volatility in Indian markets. The headlines like “Foreign Investors dumping Indian Equities” therefore are best ignored. As per Prime Database, FPIs are presently invested in 1370 listed companies in India, an all-time high number. It would therefore not correct to say that FPIs invest in only a specific set of stocks; or only large cap stocks etc. Also, presently FPIs hold ~21% of all NSE market cap as compared to ~7.3% for all mutual funds in India. Thus after promoters (~51%), FPIs collectively own the largest share in listed Indian companies.

Tuesday, March 17, 2020

Its beyond COVID-19

While the shutdown of socio-economic activity prompted by spread of coronavirus (COVID-19) is dominating the headlines, there are few more important things that may be impacted larger volatility in markets and decline in asset values.

1. Foreign investors have been net sellers in Indian equities in 5 out 6 years during 2015-2020. In the current year 2020, they have sold net Rs484bn in Indian equities. The FPI selling is certainly not COVID-19 driven. They seem worried about failure in growth acceleration, earnings drought, policy unpredictability, INR depreciation (or USD appreciation), and shrinking yield differential, amongst other things.

2. The corporate earnings growth has been anemic for past one decade. In past 6years, the Nifty earnings have growth at less than 5% CAGR. The visibility of earnings growth for next year has also diminished with recent events.

3. Multiple instances of willful defaults, frauds and regulators' apathy to investors have caused huge losses to the unsuspecting investors. The credit rating agencies and auditors have repeatedly failed in performing due diligence in performance of their duties. The mutual fund managements and fund managers have miserably failed in performance of their fiduciary duties by (a) breaching prudent exposure limits to single company, group, sector etc.; (b) subscribing to suspect quality debt; (c) failing in timely realization of collateral; and (d) failing in disclosing the true nature of the risk in various fund portfolios. Massive losses to the investors due to write down in debt securities of IL&FS, Essel Group, Vodafone, Yes Bank, etc is one major reason for investors' mistrust and disenchantment from financial markets.

4. The unusual weather in past 6 weeks has impacted the Rabi cop at many places in north India. This shall definitely impact the overall rural income; something the market was relying upon for economic recovery.

5. The collateral damage from the business disruption due to COVID-19 may impact many micro businesses materially. One quarter of poor activity may be sufficient for these micro businesses to slip into a debt spiral. The collective impact of damage to these businesses shall be visible in balance sheets of financial institutions and P&L of consumer product manufacturers in near term. We have not seen the regulators and the government rising to the occasion and proactively providing comfort to the stressed entrepreneurs.

In short, there are more worries for Indian markets besides COVID-19. Expecting sharp sustainable bounce in near term may not be an appropriate thing to do at this point in time.

Tuesday, August 20, 2019

Suggestions for stimulating the economy

Suggestions for stimulating the economy

The number of people cautioning about a deeper and longer economic slowdown in India is rising by the hour. Tata Motor's management has guided for double digit fall in automobile sales in FY20 (see here). Most auto companies have announced shut downs; some have also announced significant reduction in the employed workforce. SBI chairman is insisting on urgent need for some stimulus in almost each of his public presentations (see here). Most other senior banks and industrialists have also sounded the caution begul (see here)

The stock markets have corrected sharply in past one year; though the benchmark indices may not be reflecting the correction as yet. The wealth erosion for investors has been material. The market participants are clamoring hard for a stimulus package to bring the economy and market back on path of high growth.

Whereas, most businessmen and market participants have echoed the demand for stimulus, I have not seen many actionable solutions being suggested. Generally the solutions suggested are limited to lending rate cut, GST rate cut, and roll back of tax provision relating to surcharge and long term capital gains.

In my view, roll back of the tax provisions relating to long term capital gains and surcharge on high income non corporate entities may not add to the economic growth in any significant measure, though it might be a short term sentiment booster.

As per the available data, SBI has already cut MCLR by about 30bps post recent repo rate cut of 35bps. Current SBI MCLR (8.25%) is now ~100bps lower than the highest rate seen in early 2016. However, the current interest rate is still 300bps higher than the lowest rates we saw in 2003. Given the persistent low inflation, low money multiplier and global strong deflationary trends, there is scope for meaningful rate cut. To be effective immediately this rate cut must have some shock value. Small doses of 10-20bps cut in lending rate may take much longer to reflect in higher demand and therefore may not qualify as "stimulus".

A material cut in GST rates for automobile etc may stimulate demand. However, the impact may be somewhat neutralized as lower GST revenue shall constrict government's spending ability. In case the government chooses the path of fiscal expansion through additional market borrowing, the private investment may get crowded out. GST rate cut therefore may not be an easy option for the government to exercise.

I believe the government needs to take these conventional stimulating measures steps in adequate quantity. However, to enhance the impact of these measures, a number of additional measure aimed at boosting sentiments and stimulating higher trade volumes and activity level would be needed simultaneously.

The following are some of the illustrative measures that could be considered by the government for immediate implementation:

(a) In most parts of the country, the Ready Reckoner or Circle Rates (minimum property rates considered for levying stamp duty) are much higher than the prevailing rates of property. The government must consider bringing this minimum threshold to 10% below the prevailing market rate to stimulate transactions in property market.

(b) Capital gains of upto Rs25lacs on all constructed properties may be exempted from income tax for two years, i.e., AY21 and AY22.

(c) Capital gains on sale of gold may be exempted, provided the entire sales proceed is invested in buying one or more constructed property (residential or commercial).

(d) Concessional Housing advance by companies to their employees in next 2years may not be treated as perquisites during the term of the advance.

(e) Trading in agri commodities may be exempted from cash transaction limits completely for 2yrs, i.e, till March 2021. Post that restrictions may be applied in graded manners over next 5yrs.

(f) GST input credit for automobile purchase may be allowed for six months, i.e., October 2019 to March 2020.

(g) Upto 50% discount may be offered on power tariffs to all green field industrial units that are approved before March 2020 and begin commercial operation before March 2022.

(h) The payment time for all government contracts and supplies may be cut to 15days from the present 60-180days. All outstanding payments to contractors and suppliers may be released immediately. The arbitration and legal awards in favor of the contractors and suppliers may be honored immediately.

(i) PSU banks may be adequately recapitalized immediately.

(j) Long term corporate bonds (10yrs or more original maturity) may be treated at par with equity for capital gains taxation purposes. Periodic Interest on such bonds may be taxed @10% without any limit.

(k) CSR spend in setting up rural schools and health centers may be made tax deductible at 125% of the amount spend. The operating and maintenance expenses on such schools and health centers may also be made tax deductible.

(l) 25% capital subsidy may be provided to agri produce processing units set up in the rural areas, provided the farmers who would supply agri produce for processing to such industrial unit form a cooperative society; and such cooperative society is allotted 25% equity in such unit free of cost. Gram Sabha land may be leased to such industrial units at nominal rent.

(m) The government may make a solemn promise that the effective rate of direct taxation for any assessee shall not rise for next 3yrs

Wednesday, August 14, 2019

What do we really want?

What do we really want?

To accelerate the economic growth in order to generate more employment and improve the quality of life of Indian populace, the country indubitably needs huge amount of fresh capital.

Various economists, government agencies and expert committees have suggested that to attain optimum level of employment Indian economy would need to grow 8-10% CAGR for next decade or so.

The capital investment required by private sector to create critical infrastructure to support 8-10% GDP growth is pegged in the range of US$10-12trn over next 10yrs. Energy sector alone may need investment of more than US$1trn over next one decade.

It is well recognized fact that such kind of long term risk capital may not be available internally. Foreign investment is therefore a pre-requisite for the process of economic planning, development and growth. Any debate on path, trajectory and sustainability of growth should therefore begin with this assumption that adequate foreign capital would be available.

A pragmatic economic development and growth plan under the current circumstances should therefore acknowledge the following in the preamble itself:

(a) India needs huge amount of long term risk capital to achieve the goal of fast, equitable and sustainable economic growth and development.

(b) Meeting of this goal is materially contingent upon flow of foreign capital.

(c) Despite unprecedented liquidity sloshing the global financial system, the risk capital that could be invested for long term in an emerging market like India is scarce and circumspect.

(d) The long term risk foreign capital will come to India at its own terms and not at the whims and fancy of the politicians and myopic bureaucracy.

...do we want to follow the herd?

However, what is true for long term risk capital (commonly known as FDI) may not be true for the short term arbitrage money (commonly known as Foreign Portfolio Investment or FPI).

This is the money that usually is not invested by the owner of the money. Instead professional investors, who are paid to maximize the returns for owners of the money, exercise the control over such money. Mostly, their interest in the investment is limited to the remuneration they would get. The remuneration is usually based on the relative performance of the money invested over a small period of time (usually 12 to 24months).

In order to maximize their remuneration, these fund managers would chase the relative outperforming assets in a most secular fashion - with no regional, racial or systemic bias. They would go to communist China, chaotic Russia, democratic but unpredictable India, war torn Africa, vulnerable Chile & Columbia, or struggling Venezuela and Argentina.

As most of them usually move in a herd, they are able to cheer the target market by driving up the asset prices with huge collective inflows in a short span of time. They invariably inflict severe pain and cause huge volatility by their ruthless collective exit.

There is little evidence to establish their long term positive impact on the investee market or economy. However, there is enough anecdotal evidence to show the damaging impact of the excessive volatility caused by their collective actions.

The South East Asian economies suffered tremendously at their hands during 1990's. Emerging markets crashed during subprime led global crisis, when some many of them were growing at 8% to 10% annual rate.

India too had have few instances of irrational boom and bust cycle driven by collective withdrawal of FPI money. 1998 post nuclear blast exodus, 1999-2001 dotcom bubble and bust, 2006-2009 easy credit driven boom and bust, and 2011-12 Grexit paranoia led selling are some major instances.

Besides, we have also seen frequent collective actions to pressurize the government and regulators over issues such as taxation (MAT, DTAA, GAAR) and transparency (P. Note disclosures), etc.

On most occasions the government and the regulators have given in to the pressure, deciding to maintain the status quo. Consequently—

(a) Many nagging issues got accumulated to keep the FPIs and agencies at confrontational path for many years.

(b) The message that goes to FPIs is that Indian government and agencies accord significant importance to the stock market indices and are willing to walk extra mile for a few billion dollars of FPI flows.

Currently Indian markets are witnessing yet another instance pressure tactics. This time most of the domestic participants are also pleading with the government to yield to the FPI demands. The indications are that the government will give in yet again.

The question that may still remain unanswered is "what do we really want?"

Do we want long term risk capital that would support out economy in achieving sustainable high growth? Or do we only care for the fleeting arbitrage money that would stay in India only until a better opportunity arises in some other corner of the world.

I am certainly not denigrating the importance and need of FPI flows to Indian securities markets. But I strongly believe that unlike the long term risk capital (FDI) these flows must be on our terms and within the regulatory framework designed to ensure orderly development of securities market.

Also read Modi Says Surplus Global Liquidity An Opportunity To Access Cheaper Funds