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S. Vaidya Nathan

IN THE first nine months of 2003, foreign institutional investors (FIIs) invested more in equity than in the past. The inflows to date in 2003 at $3.10 billion exceeded the previous high of $3.06 billion in 1996. In rupee terms, the net inflows were higher by 34 per cent compared to 1996, due to erosion in the value of the rupee during this period.

Contrasting effects: The higher rupee equivalent also explains partly why FII flows have had such a pronounced impact on stock prices over the past four months. In contrast, their heightened interest in 1996 barely had an effect on stock prices. The markets closed out 1996 with modest losses of 2 per cent.

In 1996, predominantly stocks from the information technology, pharmaceutical and consumer products attracted attention. However, now, FII interest has been broad-based. Closing out strongly: A year that started off on a weak note with respect to FII flows — with $349.5 million coming in the January-March quarter, the second lowest ever — is set to end with a bang.

FII flows into equity and debt in 2003 touched $4 billion, with the latter accounting for 24 per cent. The strong trend in FII flows in recent months suggests that it could continue and sustain the ongoing rally in stocks. Usually, FIIs invest a sizeable proportion of their funds in the first and second quarters of the calendar year, with the latter being the more critical one. (However, in 2003, 57 per cent of the flows into equity came in the third quarter.) If FII flows taper off over the next three months to modest levels, following the patterns of the earlier years, there could be some downside risk to stock prices.

During this period, if the market holds its present level or takes a 10-15 per cent knock, the bout of fresh FII money in 2004 could provide a fillip to stock prices, from the current levels.

A lot would, however, hinge on how FIIs perceive relative opportunities in emerging markets, and those in the US and Japan. Going forward, the key factors look attractive, with the strength in the rupee (which has appreciated 7.2 per cent) providing a cushion that has never been available to FIIs in the past.

If the underlying growth story in the economy continues, stocks of Indian companies could hold room for appreciation on a fundamental basis, and attract sizeable FII flows in 2004.

With agricultural growth likely to pick up, this could also lift overall growth rates.

Commodity, banking, auto and engineering sector stocks appear well-placed to have a few more quarters of strong growth, unless there is an exogenous shock.

In this backdrop, liquidity — a key driver of the uptrend, with FIIs at the vanguard — may continue to play a pivotal role in influencing equity prices.

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