FII flows may revive, yet market momentum leans on domestic investors, Budget

FIIs net sold ₹146.29 crore worth of equities between 1 January and 2 July, while DIIs were net buyers, pouring in a staggering ₹2,40,627.19 crore during this period. 

The S&P BSE Sensex has risen 10% in 2024 so far, whereas Nifty 50 gained nearly 12%. 

The strong trend in DII flows, which began post-demonetisation in 2016, has intensified over the past few years due to a broader investor base rather than just a shift from physical assets like gold and real estate to financial investments.

Mutual funds (especially SIPs), direct equity investments, and contributions to insurance and pension funds, along with strong market performance, have underpinned these inflows.

Jay Kothari, global head - international business, DSP Asset Managers, said, “The average flows of DIIs since 2016 is ~$14 billion per annum (last three years average is $26 billion) vs FPI flows at ~$5.4 billion, and that highlights the strength of domestic flows."

He believes this trend is structural, so domestic flows are unlikely to drop dramatically despite the volatility led by geopolitical, macroeconomic or recent election outcome. Also, investors now buy on dips, a behaviour change seen over the last 8-10 years, he noted.

What could impact DII inflows?

Some proposals in the upcoming Budget might influence market flows in certain ways, especially if the government decides to tweak the capital gains tax regime that currently favours equity investments.

“We think changes in long-term capital gains is possibly the only key negative that the investors may be worried about, as far as the budget is concerned," said Saion Mukherjee, managing director & head of equity research, India, Nomura. In the past, there were concerns regarding changes in long-term capital gains tax. He believes an adverse change can have a short-term impact on flows and markets.

The Budget, though, is likely to continue to focus on investment-led growth and macro stability, he said. Mukherjee added that the view among investors is largely constructive going into the Budget.

DII flows are bolstered by sustained high inflows from household savings, reflecting a growing household affinity for market investments over the past 2-3 years. In the context of generally low household net financial savings, this indicates a higher allocation to risk assets and a positive sentiment among households.

“This could be tested if there is a serious and sustained market correction, or if other financial investments become relatively more attractive (either due to taxation reasons or deposit interest rates going up)," said Sunil Tirumalai, research analyst, EM & India Equity Strategy, UBS Securities.

Overall, DII flows are expected to remain dominant.

Will FIIs make a comeback soon?

For FIIs, election was a high-risk event given high expectations and valuations. The positive outcome suggests policy continuity and a favourable outlook for FII flows into India.

Foreigners are pouring money into India funds at the cost of China, Brazil, Taiwan, and South Korea, said a report by Elara Securities (India) dated 21 June.

“India dedicated flows continue to maintain strong trend postelection results with another inflow of $842mn this week after $2.4bn in the prior 2 weeks. 26% of inflows are from US (largely ETFs), 21% from Japan, 18% from Luxemburg and 15% from Ireland. Inflows also coming from S. Korea (5%) since the past 3 weeks," the report said.

Also Read: Mint Quick Edit | The great FPI exit: Will inflows revive?

A fall in interest rates globally and uncertainty around the upcoming US elections will make India a relatively attractive investment destination, Mukherjee said. “Financial year to date, FII flows have been negative at ~$3 billion and foreign holding in Indian equities at 16% are much below historical levels of 19-20% and most EM (emerging market) funds are underweight in their portfolio".

However, he sees high valuation as a key deterrent. If valuations remain high and domestic flows are robust, FIIs may limit participation.

Jefferies India’s 18 June report reveals that discussions with over 50 investors during a recent US roadshow suggest FPI flows into India could improve in the second half of 2024 as clarity on government policies emerge post budget. Additionally, a potential US Fed rate cut later in the year could be a major trigger for higher FII inflows to India.

High valuations may delay FII party

“For FIIs, India market screams quite expensive given the level of earnings growth offered by Indian companies: In our analysis, for the same growth and ROEs as elsewhere, Indian companies have a 75% premium – all else being the same (this premium used to be sub-40% pre-covid)," said Tirumalai of UBS Securities.

He said consensus growth expectations for Indian stocks are at their lowest in a decade, making it challenging for FIIs to take big incremental exposure to India.

“If there are big listings of new age/consumer tech stocks (which are mostly missing in India compared to dominant position other markets like US and China) that give exposure to the more exciting parts of the economy, FII money may be excited," Tirumalai said.

Kothari of DSP Asset Managers said the positioning from FIIs remains light as global funds are currently underweight on India while emerging market funds are marginally overweight by 100-200 bps which are certainly not euphoric and can go higher as seen historically.

“On-ground investor discussions globally give us a sense that there are many new investors who are gearing up for their maiden India investments and hence I would not be surprised if the FII flows bounce back over the next couple of years and could see $12-15 billion of inflows per annum," he said.