Sharp Spike In FPI Outflows Unlikely, Indian Markets Resilient, Says HSBC

Since the start of September, India has seen FII outflows of close to $3.1 billion after having been a recipient of flows of $18 billion since March.

Will foreign institutional investor outflows continue to weigh on the market, or will there be a rebound?

India has been one of the best performing markets in the region, led by strong macro-fundamentals driving consistent FII inflows, HSBC said.

Even during the consolidation, since the start of September 2023 (owing to the sharp rise in U.S. bond yields), India has outperformed all major regional markets, it said.

A rise in U.S. bond yield—in part due to the Fed’s hawkish policy outlook on better-than-expected economic data as well as a rise in term premium—is negative for foreign fund flows into emerging markets, and India is not isolated from this risk despite its strong macro outlook, the brokerage said in an Oct. 19 note.

“Our house view is for no additional U.S. rate hikes, but there are risks to this view, depending on the evolution of GDP growth, labour market conditions, and inflation,” the note said.

Unless the geopolitical environment deteriorates, any sharp outflows from the current levels seem unlikely, according to the brokerage.

• Despite strong FII inflows witnessed over the past several months, FII ownership of the India equity market at 17.7% (as of September end) is well below the past 10-year average of 19%. 

• Both Asia and global funds have a large underweight on Indian equities compared to their last five-year mean holdings. 

• India continues to stand out from its regional peers with strong growth, a positive earnings outlook, and attractive valuations.

HSBC expects outflows to be only a short-term risk, given that the last eight years of data suggest that India has managed to attract its fair share of fund flows, even during years with strong mainland China inflows.

“2023 is unlikely to be very different, given that funds are underweight in both India and mainland China,” the research firm said.

Barring technology and energy, most sectors have registered positive inflows year-to-date, led by industrials and financials. Despite the recent inflows, FIIs are still net buyers of financials.

The Indian equity market has been fairly resilient relative to the region, as there has been a very large and expanding domestic institutional base.

“We believe that DII flows (backed by strong flows into domestic mutual funds) will likely cushion any sharp market volatility and keep any market correction at a minimum until FIIs return to potentially drive another market rally,” HSBC said.

If the current situation is largely contained, this will make the case for an imminent rebound in FII flows, given that growth continues to stand out and mid- and small-cap rallies have left the large caps space to outperform, supported by attractive valuations (Nifty 50 PE of 19.3 times, in line with the 5-year average, FY24 earnings of 17.3% YoY), according to HSBC.