Among many concerns looming in the Indian equity markets, outflow of foreign institutional investors' (FIIs) investment is quite worrisome. This trend is contrary to what was seen last year, and hence, raises many questions including FIIs current perception about India, the money they are willing to put back in Indian equities (if at all), their concerns on Indian markets, its relative valuations, economy and sectors.
Cameron Brandt, senior global markets analyst with Emerging Portfolio Fund Research (EPFR), a US-based firm that tracks the fund flows and allocations domiciled globally with $10 trillion in total assets, has answers to many of these questions and shares it with Jitendra Kumar Gupta. Excerpts:
Can you share with us the general FII sentiment towards Indian equity markets with regard to valuations and risks?
Risks, which were submerged by the tide of liquidity that flowed into emerging markets between 2003 and 2007, are reasserting themselves, forcing FIIs to reassess nearly all the markets they have exposure to. That includes India. There have been signs of late the balance of FII opinion is swinging in India's favour.
Indian companies are relatively debt free compared to their regional peers, most of the blue chips have been hitting their earnings forecasts, the Reserve Bank of India was quite quick off the mark in terms of getting to grips with inflation and leaner times in the US spells opportunity for the IT and outsourcing sectors.
What are the concerns that are common among the foreign investors regarding the Indian equity markets?
Three issues"� oil prices, inflation and impending elections "� stand out. The three are clearly linked. It is in the government's political interests to minimise the immediate pain that will come from higher energy prices and the attendant jump in both prices and interest rates.
But, such an approach has long-term consequences for public finances, India's credit ratings and the prospects for additional economic reform.
In an ideal world, the government would leave as much to market forces as it could and voters would reward it for doing the right thing by strengthening its mandate for additional reforms.
In the real one, the poor must be protected, both on moral and political grounds, and even the modest adjustments to fuel prices made this month increase the odds of a less market-friendly government by 2Q09.
Post January 2008, FIIs have been the net sellers in the Indian equity markets. What is your outlook for the rest of the year?
After a rocky start to the year, the India Country Funds we track, whose mandates are limited to Indian equities or cash, had posted net inflows for the nine consecutive weeks ending May 28. Year-to-date flows stood at $74 million versus outflow of $745 million at the end of 1Q08 and outflow of $1.1 billion during the same period in 2007.
Looking at the numbers from the fund perspective, GEM funds are slightly underweight on India, but continue to cite it as a good long-term bet and buy on dips "� EPFR Global-tracked funds were net buyers of India in March when they were aggressively selling in most other Asian markets.
Global Fund managers are the most consistently bearish towards India: through April they had been net sellers of Indian equity for six straight months.
Last year, India Country Funds ended the year with net outflows of $761 million and EPFR global-tracked funds were net sellers of Indian equities to the tune of $853 million. If the current fund and country flow trends hold up, the comparable numbers for 2008 are likely to be positive.
Any particular Indian sector where foreign investors are bullish or bearish in the near-term?
The bullish case for IT has been helped by 1Q08 earnings and the perception that US businesses are looking for further ways to cut costs and boost productivity. There is also lot of bullish discussion about the public and private money going into India's infrastructure, although there is much less consensus about how best to play this theme.
Are FIIs worried with regard to the Indian corporate earnings under pressure, if so, what are the issues that will impact the earnings going forward?
The cost side of the equation is clearly under pressure from energy and commodity prices, the demand for skilled labour and infrastructure constraints. But, earnings expectations currently seem to be pitched at the low end of reasonable, so things will have to really go sour for them to trigger a serious flight of FII funds.
In the minds of FIIs, does the Indian equity markets still holds as long term growth story?
Yes. The past six months has shown that there is real domestic support for those markets and India's underlying economic story remains a good one: robust investment in capital goods, a central bank showing real independence, human capital returning and private enterprise playing a growing role in more and more sectors.
Do you perceive government interventions as a political risk and how do investors react?
It's a question of degrees. Most FIIs realise that triggering food riots, sending inflationary expectations soaring and improving the chances of political parties hostile to free enterprise is a high price to pay for economic orthodoxy.
So, they are willing to live with these measures, and the short-term impact they will have on specific sector earnings, as long as they feel the government is using the time these measures buy to come up with better solutions.
Is there is a change in FII perception regarding investing in the mid- or large-cap Indian companies? Has it changed during the recent past?
There's more awareness that the best value at the moment may lie in mid-caps. But, there isn't much indicating that these investors are digging into the universe of India's second/third-tier firms.
How are foreign investors looking at the rupee's depreciation? Where do you see the rupee over the next one year?
It's not an issue the funds we track are talking about. I suspect that tightening monetary policy and rising oil prices will largely cancel each other out, leaving it roughly where it is at year's end.
Was it the redemption pressure that led to the withdrawal of foreign money from the Indian markets or they are sitting in cash?
It is more a case of moving cash to the sidelines than redemptions. Since the beginning of last year, over $300 billion has piled up in the money market funds we track, with $125 billion of that flowing year-to-date. Net outflows year-to-date from GEM, Pacific and Asia ex-Japan Funds (which include India country funds) stand at $11.7 billion.
What are the near-term global cues that the FII investors are waiting for before committing fresh investments?
Stable oil prices and full discovery of the sub-prime assets in the world's financial system. Both of which, we feel are unlikely to happen much before 2H09, suggesting India will see another 6-9 months of cautious, sector and company-specific FII flows.
