It's no secret that foreign institutional investors are the movers and shakers in the Indian equity market, shaping its fortunes with their money flow. This inflow is termed 'hot money' since it is not stable and prone to huge fluctuations depending on the prevailing sentiment among the FIIs. Given their clout, FIIs have the ability to swing the market either way. If they are gung-ho about the economy and flush with liquidity, they can pump in huge amounts, creating multi-year bull runs; the 2003-7 mega rally was largely fuelled by foreign investors.
If, however, they doubt India as an investment destination, they can easily withdraw funds and spark a collapse. Their role assumes greater significance at this juncture because of the heightened uncertainty, and the recent bouts of volatility show how rapidly prices can correct or rise. Are FIIs likely to dump Indian equities at this point, and if so, which stocks and sectors will be exposed the most?
High ownership, high risk
The participants in Dalal Street are concerned because the FII holding in Indian equities is at a record high. A Citigroup report says that this figure has crossed $220 billion, which means that they hold nearly 48% of the market's free float. The FII ownership in the 30 companies that comprise the Sensex went up to 18.35% in June 2013, from 16.36% a year ago. This is also the highest level of FII holding in the Sensex in the past five years. This means that if FIIs decide to exit, the Indian equities will take a severe hit.
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The possibility of this happening is high, not only because of the problems facing the Indian economy, but also due to the expected tapering of quantitative easing measures by the US, which could suck out the FII liquidity. This would directly affect the money flow to emerging markets like India. The domestic financial institutions, including banks, mutual funds and insurance companies, do not have the clout to fight a possible pullout by FIIs. As such, the stocks with a high FII holding would be most vulnerable to a sell-off.
Goldman Sachs mentions in its report: "Very little foreign selling has occurred in the Indian equities relative to the massive foreign inflow over the past few years. We see an increasing risk of a potential flow reversal in equities, particularly in the crowded financials." Says Kartik Mehta, vice-president, research, institutional equities, Sushil Finance: "If more risks emerge, with the US Fed tapering beyond expectations or the rupee falling further, FIIs could start selling again, even if the valuations look reasonable."
However, some experts are sceptical about a large-scale pullout by foreign investors. Chandresh Nigam, CEO & MD, Axis Mutual Fund, says, "While the possibility exists, many of these FIIs have taken long-term positions in the Indian equities. A lot depends on the extent to which the US Federal Reserve tapers its quantitative measures, as well as the outlook on the emerging markets."
Sectors at risk
The FIIs have poured in over Rs 60,000 crore since the beginning of 2013. However, they have turned net sellers since June, with the net equity outflow amounting to Rs 21,657 crore, indicating a change in sentiment. The foreign ownership in the Indian equities remains concentrated, with nearly 90% in the top 100 stocks by market capitalisation. It is even more so among the top 30 stocks comprising the BSE Sensex, with 60% of their holdings in it. This exposes the large-cap stocks to FII redemption pressures.
We have already seen a partial sell-off by FIIs in private banking stocks, which have tanked considerably in the past few weeks. These remain vulnerable to the outflow as the FII holding is still quite high. Says Mehta: "Banking is typically the most vulnerable to a sell-off as it is seen as the barometer of economic health."
Apart from banking, the other sectors with high FII exposure are automobiles and FMCG. However, experts don't believe the capitulation in private banking will extend to other areas like consumption, where, too, the FII holding is high. Mehta says, "FIIs, typically, move towards safety and away from risk when there are clouds over the economy. Also, given that India continues to be a decent consumption story, FIIs are not likely to exit these stocks in droves."
A sector-wise shareholding pattern for the April-June quarter shows that the FII holding rose sharply in pharmaceuticals, fertilisers, telecom equipment and consultancy, while reducing it in tyres, IT, power generation and automobiles. Pankaj Pandey, head, research, ICICI Securities, says, "Some readjustment may happen in stocks with a higher FII holding if their performance continues to disappoint. Otherwise, I don't expect a large-scale pullout as we are better off than the other emerging market economies."