Here’s Why Foreign Portfolio Investors Can't Avoid The India Market Despite Nifty Touching New Highs

At the outset it's worth highlighting that there are signs of froth building in the Indian markets. Consider this: India’s market capitalization-to-gross domestic product ratio is around 135 per cent levels above its long-term average of around 85 per cent. Benchmark Nifty is trading at valuations which is near the top-end of its historic range. Small and mid-capitalization companies are trading at unprecedented premiums to the large-cap companies. 

While the euphoria around Indian stocks has puzzled many, it is even more surprising how foreign portfolio investors (FPIs) are turning around on India. Many had become wary about India's high valuations. They had questioned the thesis of policy continuity and India’s political strength after BJP's poor show in the general elections.

FPI U-turn = Macro Stability

It seemed that FPIs would not return in a hurry. To point out, in anyways, FPIs clout over India’s market has been declining with ownership of domestic investors in Indian equities exceeding that of foreigners since 2016.  

But, now in just a few trading sessions in July, the FPIs have pumped in Rs 7,962 crore in Indian equities. In June alone FPIs invested Rs 26,565 crore in Indian stock markets after being net seller in April and May. With this, their total investments in Indian equities now stand at Rs 11,163 crore so far in the calendar year.

What explains this U-turn by the FPIs? Are we or are we not in a bubble-like situation? If not, then what makes the current rally in Indian equities different from the earlier ones?

"This market is different from the previous bull market of 2004-2007 in at least three ways - it is characterised by macro stability implying falling correlations with global equity returns, an incessant domestic bid, and a market capitalization which makes it difficult to ignore for global investors," said Morgan Stanley in a research note on July 2.

Here is an attempt to point out a few factors that warrant FPI's interest in Indian equities going ahead. 

India's Rise In Global M-capSshare = FPIs Attention 

Over the last one-year, global market capitalization has increased by 11 per cent to US$ 12.6 trillion, whereas India’s market capitalization has significantly outperformed by surging over 40 per cent. With this, India’s share in the global market-cap now stands at an all-time high level of 4.2 per cent, above its historical average of 2.7 per cent.

"Rising index weights now makes India a market that is hard for investors to avoid. Given our growth view, it is possible that India will continue to gain share in global indices prompting both active and passive money into Indian equities," added Morgan Stanley in a note cited earlier.

Today, India is among the top 10 contributors to the global market capitalisation. To highlight, over the last year, the Morgan Stanley Composite Index (MSCI) India Index was significantly up by around 35 per cent outperforming its emerging market index MSCI EM Index by 25 percentage points.

Over the last 10 years, the MSCI India Index has outperformed the MSCI EM index by a robust 200 per cent. These kinds of precedents are difficult for foreign investors to ignore. Additionally, passive investors, even if they may have a risk-off approach to the Indian markets, end up buying India as its share increases within the emerging market fold.   

Retail Money = Less Volatility, Stable Returns

Not only historic returns have been superior, they also have been stable too. As experts put out, India is witnessing a virtuous cycle hitherto never seen before. Equity inflows by domestic institutional investors (DIIs) in the last six months at US $ 28 billion have already surpassed full-year inflows for the calendar year 2023 at US $ 22 billion. In the last three years, while FPIs have bought equity worth of US $ 0.4 billion, DII inflow stood at US $ 95.6 billion. Monthly contributions by mutual funds' systematic investment plans (SIPs) have crossed Rs 20,000 crore from under Rs 5,000 crore contribution made in 2016.

Higher domestic equity flows have not only acted as a cushion against volatility or any event-based selling by FPIs, but they also have a positive impact on valuations and the breadth of the market. This reliable supply of risk capital means less volatility and more predictable returns from equity as an asset class, which foreign investors prefer.

"Domestic inflow share has become durable and consistent due to structural shift in investor behaviour. Higher inflows are witnessed during market falls while it moderated (in the past) during intermittent highs," said a July 3 research note by ICICI Direct.

India’s Fundamentals = Low Beta

In conclusion, year 2024 is expected to be a year of volatility and underperformance for equity as an asset class globally. Global investor focus has shifted to beta generation from alpha generation. With this as backdrop, it will be difficult for FPIs to ignore India which has been one of the bright spots in the world today, more so within the emerging market context. 

The ongoing fiscal year will be the fourth consecutive year with economic growth at or above 7 per cent. Real GDP growth has averaged 6.5 per cent over the past 20 years. Importantly, inflation has been on a structurally declining path, especially after a shift by the Reserve Bank of India (RBI) to an inflation targeting framework since 2016.

This along with India's focus on fiscal consolidation has ensured that growth remains high, sustainable, and predictable - something which is very dear to long-term foreign investors. 

Stock prices are slaves to corporate earnings and thereby to valuations. Corporate profits remain in an up-cycle. According to one data set, currently, the corporate profit to GDP ratio for the Nifty-500 companies is at a 15-year high level.

"Fundamentally, India is witnessing its own mini-Goldilocks moment with excellent macros - GDP growth of 8.2 per cent in fiscal year 2023-24 on the back of around 7 per cent growth in fiscal year 2022-23, inflation at around 5 per cent, both current account and fiscal deficits well within tolerance band, stable currency, etc.), robust corporate earnings, focus on manufacturing, capex and infrastructure creation, and valuations," said brokerage firm Motilal Oswal in a recent note.