The ongoing Israel-Iran tensions and uncertainty surrounding the India-Mauritius double tax avoidance agreement (DTAA) could unsettle equity markets, potentially triggering increased outflows of foreign portfolio investments next week, warn experts. 

After being net sellers of ₹325 crore in first week of this month, FPIs came back with a buying spree last week and closed it with a net purchase of ₹ 13,347 crore as of April 12, data with depositories showed. 

With the April 2024 infusion so far, the overall net FPIs investments till date this calendar year stood at ₹24,240 crore.

FPIs had net purchased equities worth ₹35,098 crore in March and ₹1,539 crore this year. In January 2024, FPIs were net sellers in equities to the tune of ₹25,744 crore.

Trimming exposure

Friday saw big FPI selling in equities worth ₹8,027 crore on fears that those investing from Mauritius may now face greater scrutiny post the latest amendment to the India-Mauritius DTAA.

“The coming few days will be tough for FPI which might see more outflows,” warned VK Vijayakumar, Chief Investment Strategist, Geojit Financial Services. 

“Since DIIs are sitting on huge liquidity and the retail and HNIs in India are highly optimistic about the Indian market, FPI selling will be largely absorbed by domestic money”.

Vijayakumar said that latest changes to India-Mauritius DTAA will weigh on FPI inflows in the near term, till clarity emerges on the details of the new treaty.

India and Mauritius have agreed to a protocol to alter DTAA so as to introduce a provision of principal purpose test (PPT) which requires that FPIs or any other investors which are based in Mauritius need to have a commercial rationale or a justification to be based in Mauritius. 

Middle East tension

“Another major concern is the surcharged geopolitical situation in the Middle East with heightened tensions between Iran and Israel. These will keep the markets on tenterhooks in the near-term”, Vijayakumar said.

The hotter-than-expected inflation in the US has dashed hopes of three rate hikes by the Fed in 2024. Now the market is pricing in only two rate cuts, that too, towards the end of the year. Consequently, the 10-year bond yield has spiked to 4.52 per cent, triggering more FPI outflows from EMs like India, he added.

Manoj Purohit, Partner & Leader-Financial Services, Tax & Regulatory Services, BDO India, said the tax treaty amendment does not clarify whether or not past investments will be grandfathered, albeit, the PPT provision has been introduced as a non-obstante clause of the treaty. 

“It is possible to interpret that the protocol shall prevail over other provisions of the treaty, including the grandfathering provision. In line with the expectations of the offshore funds,  a formal clarification from the authorities is expected to remove any ambiguity on grandfathering of investments,” Purohit added.