The Hindu Business Line : The fall and fall of FII inflows

IN 2003, investments by foreign institutional investors started off on the weakest note in a decade, except for 1998 and 1999 — the only time in the last ten years that the FIIs were net sellers in the Indian market.

The sparse inflows mean the absence of a vital factor that props up stock prices or cushions a fall whenever there is selling pressure in the market.

It is now ten years since the FIIs made their foray into the Indian stock market. They invested around $15.5 billion during this period, and the value of their holdings is placed at around $8.5 billion.

But the FIIs now appear to be holding back, with sizeable losses on hand and, to some extent, their influence on price trends is not what it used to be in the 1996-2000 period (see accompanying story).

First quarter, the key

Typically, FII flows have been at their highest in the first two quarters of any year. Since 1993 , the January-March quarter has accounted for 42 per cent of net inflows, and the April-July quarter for 29 per cent.

But this long-term trend does not necessarily indicate what may be in store. In the last three years, for instance, there has been a significant shift in the timing of FII investments.

65 per cent of the $5.08 billion that flowed in over 2000, 2001 and 2002 came in the first quarter.

In 2002, the January-March quarter accounted for 93.2 per cent of the inflows.

An average of around 65 per cent seems a consistent trend. In 2000 and 2001, the first quarter accounted for 61.3 per cent and 59.3 per cent respectively. This may be the rule for FII investing than the exception.

Compared to the long-term trend, the second quarter share is down 6 percentage points. The last two quarters, which have virtually become insignificant, account for 12.9 per cent of all inflows between them. In this backdrop, the inflows in January-March 2003 must be viewed with some concern.

Ominous start in 2003

With just two weeks for the January-March 2003 quarter to run out, FII flows have been modest, at around $330 million. In absolute terms, this is the lowest since 1996, with the exception of the slightly unusual 1998-99 period.

This also comes on the heels of the lowest-ever net inflows in a ten-year period, in 2002. It is also highly unlikely that sizeable investments will flow in over the next two weeks to improve the picture.

If FII flows do not get a boost in April, traditionally a big-ticket month along with February and March, things could become difficult.

The war threat in Iraq has cast a shadow on stock markets across the world. Emerging market economies are particularly vulnerable to oil price spikes.

Most developed and emerging market economies are still desperately seeking economic growth targets.

Potential FII flows may tend to be lower for emerging markets as a class of assets. Most funds in the US and European markets are still trying to grapple with problems of declining stock prices in the West in the last two-and-a- half years. A war situation and a sluggish US economy may lead to considerably lower risk preferences by investors and fund managers.

These factors may drag down the level of inflows in the first and second quarters of 2003. Even if the Iraq war is short, its spillover effects on economies could be felt through the year. The only positive may be the removal of the uncertainty factor.

This alone may not ensure a spurt in FII flows in the second quarter. In this context, 2003 may well set another low or, at best, claw up to the 2002 levels, unless there is a repeat of 1995.

That year, FII inflows in July-September made up for a lacklustre show in the first two quarters. However, the trends of the past three years suggest that this prospect is remote.

FIIs trade heavily

The size of FII inflows in the last three years has been healthy at around $5.08 billion. Their active role as big-time traders is another key aspect. FIIs have been playing this role since the last quarter of 1997.

Between 1998 and 2002, their sales to purchases have been 90 per cent. Effectively, only 10 per cent of their transactions have led to fresh flows into the Indian market.

For instance, in 2002, FII flows were at their lowest. But not so their level of trading, which was close to Rs 95,000 crore.

As a percentage of this trading volume, net inflows were a mere 3.4 per cent. This effectively meant that catching the direction of FII flows was difficult for some time.

Day-trading seems to have become the order of the day for the FIIs as well. The introduction of rolling settlement has also curtailed systemic risks as a result of such activities.

The hectic trading patterns suggests the recognition that a buy-and-hold strategy may not pay. This is a key observation, valid across sectors and stocks.

Even stocks such as Hindustan Lever and HDFC Bank, prime candidates for a buy-and-hold approach, have fallen from this rather lofty perch.

Booking profits regularly has become integral to stock market operations. The FIIs seem to be doing it no different.

Exit of some FIIs

In the last 12 months, quite a few FIIs have moved out of the Indian markets, wholly or partially. Dundee, Jardine Fleming, Cazenove, Capital International, Newton and Pioneer, among others, opted out of mutual fund operations in India. A few of these players also turned their back on India as FII investors.

Even global majors such as Morgan Stanley, Merrill Lynch and Alliance Capital have shown no inclination to pursue operations actively. Alliance Capital did indicate that it might turn its back on the Indian operations before changing its mind.

Increasing pressures at home and the slew of accounting scandals and controversies over research quality have added to problems in a steadily declining market. These factors continue to be at play, and have the potential to cap the level of FII interest in the Indian market in 2003.

Sector preferences

The meltdown in the tech/telecom/media stocks at the global and Indian levels in 2000 continues to be a factor in shaping FII portfolios.

In general, the FIIs are increasingly moving towards more and more diversified portfolios. The first pointers to this came in 2001.

The quantum of investments in such areas as IT and telecom has more or less languished in the past three years.

No new dominant theme is in evidence, except for a rather belated preference for finance sector stocks by funds, with the exception of Morgan Stanley.

The latter had identified the theme but did not reap the full benefits due to a heavy exposure to frontline stocks such as SBI, ICICI Bank and HDFC Bank.

As with most other investors, FIIs were also in the forefront of investing on the expectation of strategic disinvestment in PSUs.

If the portfolios of some of Indian mutual funds with an FII parentage are anything to go by, the focus appears to be on large-cap stocks in sectors such as IT, auto and finance as well as stocks such as Grasim, Reliance and ACC, to name a few.

The sector and stock preferences are by now fairly well known to market players.

This may also be a factor in the declining importance of FII actions (especially on the buy side) for stock prices.

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