Why are FIIs fleeing Indian stocks? Blame it on bonds
As bond yields in the US start to rise, investors switch out of foreign markets, especially emerging markets, to hunt for better opportunities at home, which pressurises equities. Are Indian stock markets prepared to face the FII exodus?
The sell-off by FIIs in Indian equities has continued in October too and is feared to intensify if the geo-political crisis in the middle east escalates or the US bond yields continue to flare up
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Although India has been one of the best performers among emerging markets (EMs), foreign institutional investors (FIIs) are losing confidence in equities listed here. Blame it on US bond yields!
Indian equities suffered a withdrawal of $2.2 billion of FII money in September, in one of the sharpest single-month declines since January, as the rapid rise in US borrowing costs weighed on risk assets. This follows a robust pump of FII funds worth $20.85 billion in the previous six months, which drove the Sensex and Nifty to record highs multiple times. In fact, FIIs poured in as much as $6.72 billion and $5 billion in June and May respectively, shows a Forbes India analysis based on Bloomberg data.
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However, as US 10-year bond yields continued to rise, investors rushed to dump Indian equities, which are typically considered to be riskier assets and hence less attractive. The sell-off by FIIs in Indian equities has continued in October and is feared to intensify if the geopolitical crisis in West Asia escalates or US bond yields continue to flare up, as has been the case in the past several months.
A sharp rise in US bond yields above the 4.25 percent mark and the acceptance of the ‘higher for longer interest rate’ narrative has led to the massive FII outflow from Indian equities, explains Vinod Karki, head-equity strategy and quantitative research, ICICI Securities.
As bond yields in the US start to rise, investors increasingly switch out of foreign markets, especially the EMs, to hunt for better opportunities at home; this inevitably puts pressure on equities. The yield or rate on US treasury bonds for a 10-year period has risen to a 16-year high of 4.8 percent as the US Federal Reserve is expected to keep interest rates sufficiently higher for longer. This has a direct influence on financing costs for households and businesses.
“The global equity markets in the past few weeks is witnessing some sort of a risk-off environment amid persistently high interest rates, recent increase in crude oil prices that can lend upward pressure on inflation, some weakening of macro data globally and rise in US bond yields after not-so-encouraging comments from the US Fed, which led to the street reducing their expectations of quantum of rate cuts in 2024. This led to selling by FIIs in global equities, and EMs in particular; this had a bearing on the FII activity in India as well,” says Rupen Rajguru, head, Equity Investment and Strategy, Julius Baer India. 
With bond yields staying “higher for longer”, Fook expects equity markets to stay subdued in the fourth quarter of 2023, with little differentiation in performance among the key regions. “The huge run-up in 2Q23 was predominantly driven by expectations of peak Fed. But the rhetoric at Jackson Hole suggests that this is not the case and hence, the initial enthusiasm for interest-rate sensitive plays will see some tapering in the months ahead,” he explains.
The Palestine-Israel conflict may still present a risk for stocks, as it may possibly lead to a surge in oil prices, which had surged more than 30 percent in less than two weeks when Russia invaded Ukraine in February 2022. Brent crude oil prices have been rising, closing to $100 per barrel last month.
From 2001-2010, the average yield for US 10-year treasuries was 4.1 percent. However, aggressive monetary easing and overall economic instability drove the average yield to 2.1 percent from 2011-2021, a decline of 200 basis points. From 2011-2021, corporate bonds garnered an average yield of 2.6 percent.
