FPIs return to Indian equities in the second half of 2022, but bond flows are still in the red

• Bond flows are still in the red, with net foreign portfolio investment (FPI) flows at a negative ₹2,348 crore.
  
• However, foreign portfolio investors returned to buy in the Indian equity markets in the second half of 2022 with investments of over ₹95,000 crore.
  
• The rising US dollar and US treasury yields have resulted in FPIs shunning riskier markets, say analysts.
  

Foreign portfolio investment (FPI) outflows from India’s debt markets have narrowed but are still in the red in the second half of the year so far even as the equity market drew investments of over ₹95,000 crore in the period, reversing a massive sell-off witnessed in the first half of this year.

While the capital flows story in the equity segment has two distinctly clear trends – the first half witnessed an extensive sell-off, with the second half seeing a spectacular reversal – the trend in the debt segment has been that of a sell-off – moving from more to less.


Source: NSDL, as of December 22, 2022

“Increasing risks to the global economy have forced market players to shun riskier assets and move to the safety of the US dollar,” the Kotak Securities report added.

In its efforts to control rising inflation, which hit a high of 9.1% in July this year, the US Federal Reserve has been raising interest rates and has indicated that it is likely to continue with its hawkish stance. In 2022 so far, the US Fed has hiked interest rates seven times, totaling 425 basis points.

This monetary tightening, which has also been carried out by other major central banks, coupled with increasing fears of recession has seen foreign investors pull out money from riskier assets as they seek out safe havens.

The US dollar index, for instance, has gained 8.6% this year so far. The rupee has fallen over 11%, from 74.5 per US dollar at the beginning of the year to 82.8 as on December 23.

Also, the yields on the US bonds are climbing, encouraging investors.

“US 2-year treasury yields surged past 4.5%, while 10-year yields crossed 4% in October, as Fed maintained extreme hawkishness,” said a report by Kotak Securities.

On the other hand, the Indian government’s 10-year bond yields have remained relatively stable, between 7.2-7.5% in the second half of the year.

Foreign capital flows are also about getting the best returns. On this, equity scores higher than debt. According to a report by FundsIndia, the one-year compounded annualised return on the Nifty50 index stood at 11.9% at the end of November, compared to 3.8% on the debt index in the same period.

On the other hand, the S&P 500 index’s return stood at a negative 4.6% in this period.

Equity reversal

The strong rebound in FPI flows into Indian equities in the second half of the year – from outflows of ₹2.17 lakh crore in first half of 2022 to inflows of ₹95,199 crore in the second half – tracks investor expectations for a softening of the US Fed stance on rate hikes.

“FPI flows towards India and other emerging markets from July 2022 started to turn largely positive with bouts of moderate selling. The above behaviour could be again signalling that the aggressive rate hikes by the US Fed may be approaching its peak going ahead,” said a report by ICICI Securities.


Hitesh Jain, lead analyst at Yes Securities, explained that the strong reversal in the flows in the second half of the year was due to investments exiting Russia and finding their way to India after the breakout of the Russia-Ukraine war.

“FIIs are now pouring money into domestic-facing sectors like banks and consumption stocks, which are immune to global shocks, and traction is apparent in terms of India’s credit growth and consumer spending,” he said.

It remains to be seen how the confluence of monetary policy stances of key central banks across the world, geopolitical tensions and the fears of recession play out in 2023. Indian markets are betting that benign macroeconomic factors will help strengthen FPI flows into both the equity and debt markets.

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