Balancing act

The movement of the stock market on Monday, which crashed along with its Chinese counterpart, reflects the nervousness among investors about dwindling foreign portfolio flows. The 7 per cent decline in the benchmark index of China’s Mainland stock exchange and the consequent trading halt was mainly caused by panic selling by Chinese retail investors who feared their regulator would lift a trading ban imposed last July. This was expected to trigger a deluge of selling by large investors in China. The resulting decline in Indian stock prices was probably an overreaction. But Indian equity investors have been on edge for some time now with foreign portfolio investors turning net sellers; FPIs have pulled out ₹17,857 crore so far in 2015-16, the first time flows have been negative in a fiscal year.

Indian investors have come to rely greatly on these foreign fund flows to support stock prices as well as lift them higher. After promoters, FPIs are the largest class of shareholders, holding close to 20 per cent of listed shares, and their activity is bound to critically influence stock market behaviour. Besides slowing foreign fund flows, Indian investors have also had to deal with slowing demand, both domestic and external, hurting the revenue and earnings growth of companies. The steep decline in commodity prices, a slowing investment cycle and the burgeoning debt of companies in some sectors have also been affecting stock prices. While the list of negatives is long, there are many positive factors in favour of Indian equity at this point. The relatively superior macros, higher economic growth, declining inflation and the benefit from falling commodity prices have made foreign investors view Indian companies very favourably, and has resulted in their premium valuation in comparison with other emerging markets. It is probably due to this that foreign fund outflows from India have been far lower than other emerging markets. Largely driven by domestic consumption, the Indian economy is more insulated from a global slowdown as well.

These factors will ensure that foreign flows do not entirely dry up. But even if they do, the ongoing resurgence in domestic investor interest in stock market can help mitigate the impact to some extent. Flows into mutual funds recorded a sharp jump in 2015 and the overwhelming response to some initial public offerings shows that domestic investors are now willing to plough money into stocks. The increase in the number of investors taking the systematic investment route to investing in mutual funds and the growing popularity of direct plans of mutual funds, too, reflects maturity among Indian equity investors. The drop in interest rates is another factor that can make investors shift from fixed-income investment to equity. The regulator can also do its bit to increase domestic investor participation. It can step up market vigilance and ensure that those found guilty of frauds do not get away lightly. Greater confidence in the system can help draw a larger number of investors to stocks.

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