Investors stare at double-digit losses as rupee eats into FPI pie

Indian indices better off in 2022, down less than 2 per cent

Despite the turmoil in the equity markets, domestic investors are staring at less than 2 per cent losses so far this year. The situation, however, is very different for a foreign investor, who has invested in the Indian markets during the start of the year.

Despite Indian equities faring better than peers, the decrease in the rupee against the US dollar has resulted in double-digit losses for foreign portfolio investors (FPIs). The Dollex 30, a gauge that shows dollar-denominated returns for the benchmark Sensex index, is down 10.7 per cent, after surging over 50 per cent in the previous three-year period. The Sensex surged 61 per cent during this period.

Returns for overseas investors have been higher than for the locals only once in the past decade — in 2017 when the Sensex had gained 28 per cent in rupee terms and 36 per cent in US terms. However, the latest pressure on the rupee has made the return differential more lopsided this year. And, if the rupee slides further, it could deteriorate the return scorecard for overseas investors and impact future allocations towards the Indian market.

Between October 2021 and June 2021, FPIs had withdrawn over Rs 2 trillion from the domestic market. However, the fall in the rupee during this period was cushioned by intervention by the Reserve Bank of India (RBI). But with the RBI’s forex reserves depleting, the central bank’s hands may be tied at a time when the US bond yields and currency are skyrocketing.

“FPIs prefer to invest in countries whose currencies are expected to appreciate in the medium term as it ensures that the returns earned by them do not get diluted at the time of repatriation of capital. With the US Fed (US Federal Reserve) tightening aggressively risk aversion towards emerging markets is rising, leading to capital outflows. RBI needs to be ever vigilant that the trickle of this outflow doesn't become a torrent,” said Ajay Bodke, an independent market analyst.

Market experts say currency risk has become the key focus area for investors with most global currencies seeing a rout. Until recently, the Indian rupee was a strong outperformer vis-à-vis regional peers, thanks to strong macroeconomic fundamentals.

However, with the rupee edging close to 82 against the US dollar, its macro fundamentals could be tested.

More so, if the ongoing situation leads to sharp reversal in FPI flows. In July, FPI investments into the domestic markets turned positive after nine months. They pumped in $618 million in July and $6.4 billion in August, propelling the indices close to their lifetime highs. However, after Monday’s over Rs 5,000-crore pullout, September’s tally is on the verge of turning negative.

Analysts say the high bond yields on offer in the US and poor spread offered by the domestic markets could keep incremental flows depressed.

In the past one month, the spread between the 10-year US Treasury and India’s 10-year government security has narrowed by 100 basis points (bps) to 360 bps, most in nearly 12 years.

A study by ICICI Securities shows a narrowing spread can compress equity market valuations. “Going by the correlation in the past 20 years, the recent decline in spread can potentially put pressure on the price-to-earnings (P/E) multiple of the Nifty50 index,” it said.