Foreign portfolio investors (FPIs) have pulled out Rs 1.22 trillion ($16.58 billion) from the Indian stock market so far this year and are on course to hit the highest-ever outflows in a calendar year.
FPIs have turned net sellers in 2022 after being net buyers in the last three years.
A combination of factors such as interest rate hikes by major central banks, weakness in the rupee, fears of global recession, and a spike in commodity prices have led to continuous pullout by overseas investors from domestic stocks.
The rate hikes and monetary tightening by central banks, including the US Federal Reserve, led to risk aversion among investors, who were sceptical about whether policymakers would be able to tame inflation without triggering a recession.
The depreciation of the rupee added to the nervousness of foreign investors. On a year-to-date basis, the rupee has declined 10.2 per cent against the US dollar. A fall in the rupee eats into FPIs' returns.
The US bond yield has risen sharply to about 3.7 per cent now from 1.5 per cent at the beginning of the year amid tightening by the Fed. Supply disruptions caused by the Russia-Ukraine war led to a rise in commodity prices. Brent crude prices first surged to about $134 per barrel in March, but later corrected and are now hovering around $80 per barrel.
But despite the heavy FPI selling, the Sensex has managed a YTD gain of 4.8 per cent on the back of strong domestic flows.
'CY22 was marked with resilient flows into Indian equities by domestic mutual funds (DMFs) despite heavy outflows from FIIs. However, even with our conservative estimates, just provident funds, pension funds, insurance funds, and SIPs could contribute at least $20 billion into Indian equities in CY23,' Amish Shah, head of India research, BoFA Securities, noted in its India Year Ahead 2023 report.
Going forward, analysts said sustained FPI outflows could incrementally put pressure on the markets. However, with FPI ownership of Indian equities at a multi-year low, potential for incremental outflow is limited.
"India has done very well relative to its peers. In that respect, India has been used as a source of funds whenever there was redemption by emerging markets funds. And that will probably be the case next year," said Andrew Holland, CEO, Avendus Capital Alternate Strategies.
"If emerging markets do well on the back of stabilising interest rates globally, markets like China, Korea and other emerging markets will receive more flows. India will receive flows but not as large as some other countries," Holland added.
U R Bhat, co-founder of Alphaniti Fintech, said interest rates in the US were likely to peak at 5 per cent.
"If that happens, there won't be a huge damage to equity markets as long as the Covid situation is under control," he said.
"Emerging markets which are doing well including India will attract flows. We might even get flows outside of the emerging market funds due to our economy's outperformance."