FPIs - Increase in Selling and Concerns

Why in News?

Recently the outflow of foreign portfolio investors are high and raised serious concerns.

What is FPIs?

• FPI – Foreign Portfolio Investors (FPIs) are non-resident individuals, institutions, or entities that invest in a country's financial assets—such as stocks, bonds, and mutual funds—without seeking direct ownership or managerial control.
• They offer appreciation high liquidity and enable international diversification, primarily investing for short-to-medium-term capital.
• Recent trend – Foreign Portfolio Investor (FPI) outflows from India since October 2024 have been persistent and significant, amounting to over $45 billion in 18 months.
• Concerns – This sustained selling has raised concerns about India’s attractiveness as an investment destination.
• Despite strong domestic inflows, FPIs continue to remain net sellers.
• Understanding this phenomenon requires an analysis of valuation concerns, shifting global dynamics, structural challenges, and evolving investor perceptions.

What are the scale and persistence of FPI outflows?

• Exceeding previous level – The magnitude of FPI selling is notable, even exceeding levels seen during the Global Financial Crisis in terms of market capitalisation impact.
• India has underperformed emerging markets (EMs) by nearly 5,000 basis points, and foreign ownership has dropped to a 15-year low.
• Deeper change – This trend reflects a deeper shift rather than short-term volatility.
• While domestic institutional investors (DIIs) have provided stability, the absence of foreign capital inflows has affected overall market sentiment and relative performance.
• Valuation concerns – A primary driver of FPI selling is India’s elevated valuation relative to other emerging markets.
• Even after recent corrections, Indian equities trade at a nearly 50% premium to EM averages.
• From an investor’s perspective:
  • Paying ~20x earnings for 10–15% growth appears unattractive.
  • Comparable or higher growth opportunities exist in other markets at lower valuations.
• Valuation multiples reflect expectations of:
  • Sustained growth
  • High return on equity (RoE)
  • Predictability of earnings
• The recent compression in multiples indicates declining confidence in either the pace or duration of India’s growth story.

What are the changing global investment landscape?

• Earlier scenario – India was perceived as the “only game in town” among emerging markets.
• However, this narrative has shifted significantly.
• Re-emergence of competing markets – China is regaining investor confidence due to policy stability and leadership in sectors like EVs, AI, and renewables.
• Taiwan dominates semiconductor manufacturing, making it indispensable.
• South Korea is witnessing corporate governance reforms, improving investor sentiment.
• Brazil offers opportunities in commodities and cyclical sectors.
• India is no longer the sole large, liquid, growth-oriented EM option. Increased alternatives have led to portfolio rebalancing.
• Growth concerns and sectoral stagnation – A key concern among FPIs is that India’s earnings growth may be structurally capped at 10–15%.

What are the Sectoral Challenges?

• IT services – Facing disruption from Artificial Intelligence (AI).
• Private banks – Competition from revitalized public sector banks.
• Consumer staples – Viewed as overvalued with limited growth upside.
• Pharmaceuticals – Transition challenges towards biosimilars.
• With traditional sectors stagnating and new-age sectors underrepresented, investors question the sustainability of higher earnings growth.
• Innovation deficit and technological leadership – Global investors increasingly prioritize innovation-driven economies.
• India faces a perception challenge in this regard:
  • Lack of dominance in sunrise sectors like AI, robotics, or advanced biotechnology.
  • Limited global market share in high-tech manufacturing.
  • Even in traditional strengths like IT and pharmaceuticals, India is not seen at the cutting edge of innovation compared to global peers.
• This raises concerns about the quality and durability of long-term growth.

What are the concerns and challenges?

• China-Plus-One Strategy – India was expected to benefit significantly from global supply chain diversification under the “China-plus-one” strategy.
• However, progress has been slower than anticipated:
  • Manufacturing investments from multinational corporations (MNCs) remain limited.
  • Foreign Direct Investment (FDI) inflows have stagnated.
• Structural issues such as regulatory complexity, land acquisition challenges, and infrastructure gaps continue to hinder large-scale manufacturing expansion.
• Ease of Doing Business and Regulatory Concerns – Investor perception of India as a difficult market persists:
  • Complex tax structures and retrospective taxation concerns
  • Regulatory unpredictability
  • Compliance burdens
• While these challenges were previously overlooked due to strong returns, they have now become significant deterrents in a lower-return environment.
• AI Disruption and India’s Economic Model – Artificial Intelligence poses a structural challenge to India’s services-led growth model:
  • India’s IT sector relies heavily on billable human hours.
  • AI-driven automation threatens this cost advantage.
  • If productivity gains from AI reduce demand for outsourced services, India’s core export sector could face long-term pressure.
• Cyclical vs Structural Factors – It is important to distinguish between cyclical and structural drivers:
• Cyclical factors
  • Global capital rotation towards North Asia.
  • Short-term earnings acceleration in AI-linked sectors abroad.
  • Temporary sentiment-driven outflows.
• Structural factors
  • High valuation premium.
  • Limited innovation leadership.
  • Slower-than-expected manufacturing growth.
  • Regulatory bottlenecks.
• While cyclical factors may reverse, structural issues require policy and corporate intervention.

What should be done?

• Policy measures – Simplifying regulatory frameworks.
• Enhancing ease of doing business.
• Providing stable and predictable tax policies.
• Economic strategy – Accelerating manufacturing under global supply chain shifts.
• Promoting high-tech industries and innovation ecosystems.
• Increasing R&D investments.
• Corporate actions – Greater capital expenditure (capex).
• Focus on productivity and technological adoption.
• Expansion into emerging sectors.
• A contrarian perspective – Despite current negativity, there are reasons for cautious optimism:
  • Domestic flows remain robust, providing market stability.
  • India’s macroeconomic fundamentals—demographics, consumption base, and digital infrastructure—remain strong.
  • Negative sentiment itself may act as a contrarian indicator for future inflows.
• The argument that India cannot innovate or sustain growth may be overstated, as structural reforms and private sector dynamism could revive the growth narrative.

What lies ahead?

• FPI selling in India is driven by a combination of high valuations, shifting global opportunities, and structural concerns regarding growth and innovation.
• While the country is no longer the default choice among emerging markets, its long-term fundamentals remain intact.
• Addressing regulatory bottlenecks, fostering innovation, and accelerating manufacturing growth are critical to restoring investor confidence.
• Although near-term challenges persist, India’s economic trajectory still holds promise, making the current phase one of recalibration rather than decline.

Reference

Business Standards| FPI Selling