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As volatility gripped global markets last week, foreign portfolio investors net sold $938 million worth of Indian equity. With the Federal Reserve embarking on monetary tightening, foreign fund flows into India are likely to be negatively impacted over the next 2 to 3 years.
The excessive liquidity pumped into the system by the Fed and the burgeoning dollar-denominated credit, spurred by near-zero rates in the US, have found their way into all emerging markets, including India.
According to the IMF’s Global Financial Stability Report, about $260 billion in portfolio inflows into emerging market economies since 2010 can be attributed to the unconventional policies of the Federal Reserve. With the Fed moving towards monetary policy normalisation, the IMF estimates that portfolio flows into EMEs can reduce by about $35 billion a year.
Strong link
There appears to be a strong link between the Fed’s monetary easing and portfolio flows into India. The Fed’s asset purchases since 2009, to infuse liquidity into the US economy, resulted in expanding the Fed’s balance sheet from $865 billion in August 2007 to $4.5 trillion by the end of 2014.
It also slashed the policy rate aggressively, from 5.25 per cent in June 2006 to 0.25 per cent in December 2008. Borrowers made the most of these low interest rates and liquidity to invest in asset classes across the globe.
Some of this money has come into India. Foreign portfolio flows into the Indian equity market hit record highs between 2009 and 2014, averaging $15 billion of annual flows in that period. Inflows in 2010, 2012 and 2013 exceeded $20 billion.
The Fed stopped buying assets in 2015 and began hiking its policy rates in December 2015. Annual FPI inflows into India have also tapered since 2015, averaging around $5 billion, despite fairly robust stock market performances in 2016 and 2017.
FPIs from the US
This strong link with the Fed’s policies could be because the Indian stock market receives the largest quantum of inflows from the US. According to SEBI, FPIs from US held ₹9,82,055 crore of stocks towards the end of December 2017, accounting for 35 per cent of the total FPI holding in Indian equity. As a percentage of the total market capitalisation in India, FPIs from the US account for 6.66 per cent.
With the Fed moving to shrink its balance sheet since October 2017, liquidity in the US is expected to tighten, impacting foreign fund flows. What is more worrying is the future rate hikes planned by the Fed. The policy rate has been hiked five times between December 2015 and 2017, taking it to the range of 1.25 to 1.5 per cent; these are projected to increase to 2.1 per cent by end 2018 and 2.9 per cent by the end of 2019.
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