Inflation, war and Fed hawkishness drive FII selling in FY22

4 Apr 2022 , 10:55 AM

Fiscal year 2021-22 has concluded and the big story of the year was rampant selling by the foreign portfolio investors (FPIs). The selling was spasmodic in the first 6 months, but from Oct-21 to Mar-22, the second half was dominated by relentless FPI selling. We will come back to the reasons for the sell-off later, but here is a quick look at how FPI selling panned out through fiscal year 2021-22

Story of FPI flows in 2021-22

The table below captures the monthly FPI flows for FY22, which have been split between IPO flows and secondary market flows.

Month FY22	FPI flows (Rs cr) Secondary Markets	FPI flows (Rs cr) IPO Markets	Overall monthly FPI flows (Rs cr)	Cumulative FPI flows (Rs cr)
Apr-21	-9,705.57	46.43	-9,659.14	-9,659.14
May-21	-6,931.05	3,976.71	-2,954.34	-12,613.48
Jun-21	9,607.01	7,608.00	17,215.01	4,601.53
Jul-21	-17,482.02	6,173.66	-11,308.36	-6,706.83
Aug-21	-6,104.63	8,187.57	2,082.94	-4,623.89
Sep-21	11,858.83	1,294.86	13,153.69	8,529.80
Oct-21	-14,475.68	926.01	-13,549.67	-5,019.87
Nov-21	-33,799.66	27,854.56	-5,945.10	-10,964.97
Dec-21	-32,689.55	13,663.49	-19,026.06	-29,991.03
Jan-22	-33,138.96	-164.49	-33,303.45	-63,294.48
Feb-22	-38,615.84	3,023.86	-35,591.98	-98,886.46
Mar-22	-40,055.73	-1,067.41	-41,123.14	-140,009.60
Total	-211,532.85	71,523.25	-140,009.60

Data Source: NSDL

A quick look at the above data of FPI flows helps us draw quick inferences of FPI flows for financial year 2021-22.

- Net full year FPI outflows of Rs140,010cr only tells us part of the story as this figure has been largely mellowed by the sharp IPO inflows from FPIs during the year.

- While FPI inflows into IPOs stood at Rs71,523cr ($9.47 billion), the secondary market outflows by FPIs were to the tune of Rs211,533cr ($28.01 billion).

- The net selling by FPIs of Rs140,010 ($18.54 billion) represents the highest ever net selling by FPIs in any single financial year in the last 27 years.

- The selling intensified since Oct-22. In fact, at the end of Sep-21, the net FPI flows into India were still positive. The selling momentum accelerated from October 2021 onwards and gathered pace through the second half.

- While FPI flows into IPOs tapered after the digital stock sell-off, the sector that saw huge outflows from secondary markets were banking, NBFCs and IT.

While there had been global risk-off selling through the year, Indian markets saw aggressive selling due to relatively higher valuations as well as profits on the table for FPIs.

What triggered such a massive FPI sell-off in FY22?

There were a number of reasons for the massive sell-off during fiscal year FY22.

a) The first big reason for aggressive FPI selling was Fed hawkishness. The rate hikes may have started only in Mar-22 but indications were around for a long time. The US economy reported Feb-22 inflation at a 40-year high of 7.9%. Fed has hiked rates by 25 bps and guided for another 6 rate hikes in 2022. This aggression means; risk-off flows into the US markets, selling in emerging markets like India, weakening of the INR as well as a compulsion for the RBI to follow suit and raise repo rates.

b) Related to the Fed rate hikes, is the liquidity unwinding. The fresh buying of $120 billion of securities has been fully unwound by the Fed as of March 2022. However, the bigger risk is of Fed aggressively unwinding the $9 trillion bond book this year. That would tighten liquidity in the global system and negatively impact passive flows into India from ETFs and index funds. That was a major factor that led to FPI selling.

c) Too much cost inflation was a key factor for FPI selling. In India, the retail inflation may still be around 6%, but the WPI wholesale inflation is well above the range of 12-13%. The impact is palpable all around. Prices of crude oil, aluminium, copper, paper, chemicals, gas have all gone up sharply in the last one year due to supply chain constraints. The supply has just been unable to keep pace with the recovery in demand. That has resulted in a number of key sectors like paints, FMCG, autos and chemicals facing serious operating margin damage in the last 2 quarters. FPIs are worried that the trend could get accentuated in the coming quarters.

d) One important reason for the FPI selling in the last one year has been fears of persisting weakness in the rupee. Most FPIs are of the view that the rupee could get impacted by a number of factors. Firstly, spike in oil prices would impact the rupee due to India’s 85% dependence on imported crude. Secondly, the widening current account deficit (now at 2.7% of GDP) has traditionally weakened the Indian rupee. Above all, rate hikes in the US would strengthen the dollar index and devalue the rupee. When the rupee weakens, the foreign investors get less when they convert rupees back to dollars and this reduces dollar returns. The prospects of a sharp fall in the rupee also triggered FPI selling.

e) Finally, there was the big geopolitical risk of the ongoing war between Russia and Ukraine. While, India may not have deep trade links with Russia, most FPIs thought it would be better to exit the vulnerable markets at this point of time and stay invested in low risk markets and low-risk assets.

In short, it was a combination of all the above factors that triggered the sell-off by FPIs.

But, the real story was about Indian market resilience

In normal market conditions, $18.5 billion of net FPI selling would have resulted in Indian indices cracking sharply. In 2008 and 2013, the indices fell vertically with much lower levels of FPI selling. Ironically, in an year when the FPIs withdrew $18.5 billion, the Nifty and Sensex actually closed 18.9% higher. What explains this anomaly?

For starters, FPI selling in debt was not too acute, which avoided a major crash in the rupee, but there was more to it. Domestic institutions with deep pockets have been consistent buyers at each dip and that ensured support. Above all, Indian markets have seen a surge in demat and trading accounts as retail investors have taken to equities like fish to water. The moral of the story is that Indian markets have finally shown resilience in the true sense of the term. FPI selling is losing its shock value for Indian markets and that is a positive!