Foreign inflows into Indian equities have declined sharply in last 5 years. Here's why

Foreign portfolio investments in Indian equities have declined sharply to $18 billion in the last five years (2014-2018) from $94 billion in the previous five (2009-2013), a report by IIFL Institutional Equities said.

Other emerging markets (EMs) too experienced a drop in foreign flows into equity markets. Foreign portfolio investments into EM equities were affected by the US Fed’s quantitative easing (QE) program, the report stated. The Fed stopped purchasing assets (Treasuries/Mortgage Securities, etc.) from October 2014 and began unwinding QE from October 2017.

Partly due to that, the aggregate equity inflows to emerging economies declined to $276 billion during the five-year period of 2014-18 from $462 billion in the previous five-year period of 2009-13.

However, the decline in share of equity flows into India suggests that FIIs have preferred other EMs over India in recent years, the report quoted, adding that China has been the largest recipient of FII flows in the last five years, partly aided by the decision to include China A-shares in the MSCI EM index, which led to the rise in weight of China equities in the index.

Inflows to India accounted for only 7 percent of FII equity inflows in EMs of the last five years (CY14-18) compared with 20 percent share in the previous five years (CY09-13).

As per IIFL, another reason for the declining preference of Indian equities is the richer valuation as compared to EM equities, despite the narrowing gap of return ratios. "India has historically commanded premium valuations relative to other EMs due to superior valuations and relatively better disclosure standards. However, the profitability of Indian corporates has worsened over the last decade and aggregate RoE of Indian equities is now similar to other EMs’. Despite this, Indian equities have a richer valuation," the report said.

Further, FII investments in primary markets have been significantly higher than those in secondary markets over the last few years. In three of the four years since CY15, primary markets have received higher FII inflows compared with secondary markets. Cumulatively, FIIs have invested $16 billion in primary equity markets in the last five years (CY14-18) compared with an investment of $10 billion in secondary equity markets during the same period, the report said.

Moreover, now mutual fund collections for equity investments have jumped up sharply in the last five years, even as household financial savings have continued to slide. According to the brokerage, this suggests a shift, in household preference for savings from traditional instruments such as bank deposits, to capital markets. Mutual funds have collected $103 billion for equity investments in the last five years (CY14-18) compared

with the redemption of $6 billion in the previous five years (CY09-13).

This has led to MFs replacing FIIs as the dominant players in Indian equity markets.

The analysis of foreign portfolio flows into EM equities is based on Balance-of-Payment (BoP) statistics of 15 countries — Brazil, Chile, China, Czech Republic, Hungary, India, Indonesia, Mexico, Philippines, Poland, Russia, South Africa, South Korea, Thailand, and Turkey. Valuations and return on equity (RoE) data are based on the benchmark indices of these fifteen countries.