Will FIIs push Indian markets up this year? The stage looks set for a grand show

As part of the investment strategy, market watchers believe FIIs would be looking to re-enter stocks of companies they sold off in the last couple of years which comprises substantial holding in large private sector banks. Image: Shutterstock

In 2022, foreign investors cashed out of Indian stocks. The massive sell-off did not deter domestic investors though. Mutual funds and retail investors drove the market to new highs. In 2023, foreign investors sent mixed cues. In the first two months they exited holdings to the tune of Rs32,000 crore, only to return as net buyers of stocks worth nearly Rs1.69 lakh crore over the next six months. They continued the selling spree until end-November. But December marked a major shift in strategy as they sprang into action to join the bull-run on Dalal Street.

What changed?

The sudden pivot by the US Federal Reserve in its December meeting was a surprise. The US central bank signalled three rate cuts in 2024 and went as far as it could to indicate it had ended the most aggressive rate-hiking cycle seen in decades. The fall in US bond yields and the slump in the greenback nudged investors to increase allocations in emerging markets.

India’s share in the MSCI Emerging Market Index has doubled to nearly 14 percent over the past decade and is expected to increase given the lack of appetite for China stocks after it dragged the performance of the index with flat returns in the last 10 years. “Risk appetite in China is shockingly low; market apathy is spreading to economic outlook,” Bank of America said in a recent investor survey. Foreign portfolio allocations have been shifting to Asian markets such as Japan, Taiwan, Korea and India.  

As part of the investment strategy, market watchers believe FIIs would be looking to re-enter stocks of companies they sold off in the last couple of years which comprises substantial holding in large private sector banks. In fact, banks and financial institutions are among the top picks for global investors looking to ride India’s growth story. Also, the improvement in asset quality has resulted in stronger bank and corporate balance sheets, and this has strengthened the confidence of investors.

The government’s thrust on capital expenditure to kickstart the growth cycle pushed India’s GDP growth to 7.6 percent in the September-quarter. Most economists see India’s GDP growth around the 7 percent mark in FY24. The current account deficit is seen at about 1.3 percent of the GDP and exports have been resilient despite headwinds in many western markets. Foreign exchange reserves at $623 billion are at a 22-month high and the overall macro-outlook is stable.

As the world’s fastest growing global economy with the world’s largest young population, India is an attractive consumer market and high-growth domestic companies with strong governance and attractive valuations are a big draw for foreign investors. Goldman Sachs expects corporate profit of MSCI India companies to grow 15 percent in 2024 (and 14 percent in 2025).

“We expect NIFTY to reach 23,500 by end-2024, which implies 9 percent INR price/12 percent USD total returns for 2024, led by mid-teen earnings. We retain our preference for domestic (over external) sectors and large caps (over mid/small caps) and refresh various cyclical and medium-term alpha ideas,” Goldman Sachs’ analysts said in a report. “We stay overweight Indian equities within the regional context given its superior structural growth prospects.”

In 2023, for instance, headline large-cap indices rallied 20 percent and mid and small-caps went up by 50 to 60 percent. But the foreign brokerage now sees opportunities in the large-cap space with focus on high-growth companies with reasonable valuations in sectors such as defence, energy transition, and the Make in India theme.

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Goldman Sachs is overweight banks, autos, industrials, and utilities. “India continues to offer a wide array of alpha-generating themes. As investors look to raise their India exposure, good quality companies with stable growth (high earnings and sales growth reliability) and high expected ROEs, that are trading at reasonable valuations, are likely to do well. From a style perspective, valuations for MSCI India top-quartile ‘quality’ stocks have de-rated from elevated levels and appear reasonable,” its analysts said in the note mentioned earlier.

However, the relatively high valuation of Indian stocks—currently trading at around 22x which is higher than most emerging market peers—remains a concern for foreign investors. But analysts expect corporate earnings to catch up and valuations to moderate in the course of the year.

While FII flows into India picked up in November and December, the overall foreign ownership in BSE 200 stocks is near the bottom decile since 2013. Many global funds are still underweight and the allocation of Emerging Market Asia funds is low.

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“We think foreign inflows could persist given the supportive global risk appetite and strong domestic fundamentals. Additionally, domestic retail flows via the SIP route remain sticky amid the rapid financialisation of household savings and are likely to remain a key source of equity demand,” Goldman Sachs analysts say.

The rise in participation of retail investors in domestic stock markets cushioned the impact of FII selling post-Covid. Domestic institutional investors were also big buyers and they increased allocations across large, small, and mid-cap stocks. “In the last two to three years, one of the big changes which has happened is the mass or retail participation in equity. From Covid, January-February 2020, anywhere between 2 million and 4 million customers are entering the stock market every month. This is unprecedented and almost 10x-12x to what was happening before. We are actually witnessing a revolution. This is headed to become 300 or 400 million,” Raamdeo Agrawal, chairman, Motilal Oswal, says in an interview.

Agrawal suspects the allure of foreign investors will decline over time as the retail revolution gathers force. “The power of FIIs is already muted. They have some power because they own 18-20 percent of the market. But as we go forward, if FIIs don't acknowledge this, I think they will become a thing of the past, in the sense, they will not be powerful. The local retail will become very powerful. So, I think this is a time of changes,” he adds.