FPIs Cautious on Indian Equities

Foreign portfolio investors are taking a very guarded approach to Indian equities and are holding back on their allocations to India following the continued delays in both earnings recovery and the depreciation of the rupee. As per data from the NSDL, there has been a further net outflow of approximately $3.97 billion in January so far this year, the ongoing large volume of selling from the previous calendar year was over $18.9 billion. Emkay Global has noted that, in U.S. fund meetings, global investors do not currently view India as their top investment destination.

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This trend reflects the overall concern regarding the trends in both corporate profits and currency stability. Many overseas funds are waiting for clearer signs of growth before increasing their exposure to India; the ongoing market discussions reflect continuing uncertainty that leads to a wait-and-see strategy.

Earnings Recovery Lags Expectations

Corporate earnings growth for every key sector in the Indian market (including IT, staples, banks, etc.) has been below expectations. Street estimates for Nifty50 EPS for the financial year ending March are for a 14% increase, down from 3% the previous year and only 7% in the prior year; repeated earnings downgrades have resulted in almost no confidence that there will be an immediate recovery in earnings.

Many of the larger sectors within India are experiencing a massive slowdown in their structural rate of growth, leading to what many see as overly optimistic consensus estimates. FPIs closely monitor these trends and will not invest in developing momentum until these trends are re-established. As such, global investors remain on the sidelines due to this uncertainty and reluctance to take on additional risk.

Rupee Weakness and Valuation Pressures

The rupee against the U.S. dollar has declined approximately 7.5% since tariffs were applied in the United States in April, primarily discouraging/mitigating dollar returns regardless of the dollar's recent strength against a basket of other global currencies. Expectations of an India-U.S. trade deal have many investors hopeful for help with the rupee's volatility.

High valuations give these stocks cautiousness (without strong earnings growth) as they are trading at relatively high multiples during a slow growth environment, and thus warrant only selective investment. Institutions will have some interest in the financial, industrial, and discretionary mid-cap companies; however, tech continues to be avoided.

Selective FPI Interest Areas

Small and mid-cap company stocks offer the FPI through their small and mid-cap holdings potential alpha; however, because of their high volatility, FPIs are exercising close to maximum levels of due diligence with respect to valuations. This provides these stocks with relative appeal amidst the more extensive uncertainty for large-cap companies because of their ability to expand without support from large established brands.

While RBI's ongoing support is providing some cushioning for the flow of capital into Indian companies, other Asian countries are also suffering in a similar fashion. FPI ownership of mid-cap companies is now at the highest level it has been for several years, and those investing in those securities can anticipate the same level of long-term and short-term growth as evidenced by the long-only and hedge fund investments identified by Emkay Global's research.