On the first day of 2020, it is time to look back at the FII activity in the calendar year 2019. The year 2019 assumed significance because the previous year 2018 had seen the biggest FII outflows in history. For the calendar year 2018, FIIs pulled out a sum of Rs25,000cr from equity and Rs51,000cr from debt. It is in this context that the FII flows in 2019 need to be viewed.
After a tepid 2018, the year 2019 has certainly seen a sharp turnaround in FII flows with over Rs117,000cr being infused into India in the full calendar year. If one breaks up the equity flows during the year, it can be divided into 3 phases.
Phase 1 – FII Equity flows pick up post February 2019
The first phase of positive equity flows from FIIs started around February and continued all the way to May. During this phase, FIIs infused nearly Rs60,000cr into equities. This was largely driven by hopes that the NDA government would return with a majority, as indicated by pre-poll estimates. This came as a relief to foreign investors. FIIs had been worried about the future course of reforms after the series of state level election reverses for the NDA in late 2018. However, the pre poll estimates gave hope to the FIIs that the reforms process would not be hindered and that led to a surge in FII flows between February and May.
Phase 2 – FIIs heavily sell out of equities post the July Union Budget
The poll outcome in May virtually mirrored the euphoria of the exit polls. The ruling NDA not only improved its seat tally but also managed to increase its vote share across India. However, as in most cases the FII flows stabilized after the election outcome since there was no surprise element left other than Budget Expectations. However, the full budget presented in July disappointed on multiple counts.
Firstly, the budget announced that all companies will have to increase their public shareholdings from 25% to 35%. This would have forced a lot of paper in the market. Secondly, the budget proposed a steep buyback tax of 20%, which almost appeared designed to discourage buybacks as an alternative to dividend payouts. The biggest disappointment came from the higher surcharge on the super rich categories. The only catch was that this would also include FIIs structured as trusts. The budget spooked global investors as they rushed to withdraw nearly Rs40,000cr over the next 3 months.
Phase 3 – Corporate tax cuts brings FIIs back into equities in droves
FII sentiments turned around in late September after the finance minister announced liberal cuts in corporate tax rates. The 30% rate of tax was replaced with a flat 22%, sans rebates and exemptions. This made sense to Indian companies with higher effective tax rates. In addition, MAT was scrapped while a special concessional tax of 15% was offered for new manufacturing units. The expected benefit to Indian companies was Rs145,000cr and that had to translate into value in the stock markets. FIIs were back into equities in droves and infused close to Rs50,000cr in the last 3 months of the year. This trend accentuated in the last quarter with the MSCI EM index increasing its India weightage to 9.6%.
FII Debt flows pick up in the second half of 2019
While debt flows were tepid in the first half of the year, the second half has seen a pick-up in FII flows into debt. With the RBI cutting rates by 135 bps till October, existing bonds were making money but fresh bond investments were not attractive. The only attraction in Indian debt was the high real rate of interest at 4%. By the second half of the year, the real rates had dipped to 1% due to rising inflation and falling rates. Naturally, FIIs did not find yields attractive.
However, the flows into debt picked up in the second half of the year. Sustained intervention by the RBI in the currency markets ensured that the rupee took support at around the 72/$ mark. For FIIs, buying bonds with a stable to strong rupee became more of a currency game. The rupee strength more than made up for the weak bond yield scenario. This rupee carry trade explains Rs30,000cr of FII flows into the debt markets post June.
The positive FII inflow on the equity and debt front in 2019, represents a smart recovery from the pessimism of 2018. That is the big takeaway in terms of FII flows in 2019.