The spectre of rate hikes could drive further FII outflows from India


Foreign institutional investors (FIIs) continue to be on a selling spree as far as their holdings in Indian stocks are concerned. April was the seventh consecutive month of FIIs being net sellers, with outflows at $3.8 billion, showed an analysis by Motilal Oswal Financial Services Ltd. “The increase in volatility was led by weak global cues, with concerns around inflation and potential rate hikes sparking a risk-off globally, leading to elevated FII outflows from India,” the domestic brokerage house said in a report on 2 May.

While domestic institutional investors have been lending support to Indian equities, preventing a steep fall, the outcomes of upcoming central bank meetings could result in more FIIs selling Indian shares. Domestic inflows into the Indian market continued for the 14th consecutive month at $3.1 billion in April, according to the Motilal Oswal report.

The crucial US Federal Reserve meeting ends on 4 May. A wide-held expectation is of a 50 basis points rate hike given that retail inflation in the US is at a four-decade high amid concerns of slowing growth. One basis point is one hundredth of a percentage point.

“Early indications are now pointing to 2Q GDP likely in the 2.5-3.0% range, which combined with the elevated inflation pressures should ensure a 50bp rate hike next week from the Federal Reserve and a further 50bp in June and July as a minimum,” James Knightley, chief international economist at ING said in a note on 29 April. Further, analysts at Nomura Inc foresee a 25bps rate hike by the Bank of England. Interestingly, on Tuesday, the Reserve Bank of Australia, raised interest rates by 25bps, ahead of the 15bps estimated by many economists.

Note that interest rate increases make emerging markets (EMs) less attractive investment options for foreign investors. Also, the impact of the Russia-Ukraine crisis on emerging market economies is expected to be more severe than their developed market counterparts given that many EMs are net importers of several commodities.

In the case of India, the International Monetary Fund and the World Bank recently trimmed their respective economic forecasts for fiscal year 2023. These institutions have cited high energy and food prices led by the Russia-Ukraine conflict as factors that will weigh on the country’s economic growth.

In this backdrop, the expensive valuations of the Indian equity market could be another dampener for foreign investors. “In price-to-earnings terms, MSCI India is trading at a 99% premium to MSCI EM, above its historical average of 60%,” added the Motilal Oswal report.

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