If you look at the cumulative FII activity chart between Feb-14 and Mar-13, the FIIs have been sellers on all days except one. What is more, the total FII selling in the last one month has been Rs41,552cr (~$7 billion). That is a lot more than the Indian markets can handle, especially since FII selling is normally accompanied by rupee weakening.
One explanation is that FIIs have been selling to create a war chest for IPOs. But that hardly looks acceptable. For example, the total FII allotment in the SBI Cards IPO was just about Rs.2200 crore. That hardly explains $7 billion of sell-off. The actual reason was a shift from risk-on to risk-off. Here are the specific reasons.
Coronavirus spoils the growth story
Coronavirus has already resulted in over 4000 deaths and devastated large swathes of China. With China being a major market as well as an important part of the supply chain for inputs, the impact on global growth was immediate. The impact of the virus was most evident in the oil prices which crashed nearly 50% in 3 months after China reported a 25% compression in crude oil demand.
FIIs are expecting a sharp fall in India’s Q4 GDP
India’s Q3 GDP showed a marginal pick up to 4.7% but there was too much optimism built into the Q4 projections; 5.8% in Q4 was always a tough ask, but the slowdown driven by the Coronavirus may push the fourth quarter much lower. Markets had finally reconciled to lower growth in 2020 and 2021. With Moody’s sharply downgrading India’s growth for 2021, the big India story comes into question.
WHO declares the Coronavirus a pandemic
In all the categories of epidemics, the pandemic is of the highest order as it poses a major health risk to all nations. The virus has surely spread rapidly and WHO declaring it a pandemic will impel a lot of countries to tighten their visa formalities, screening and quarantine processes etc. This could have a major impact on the flow of tourists and hit jobs as well as business segments like hotels, airlines, allied services etc.
India and the US almost close their doors to foreign tourists
There have been severe embargoes placed by the US and India. India has suspended all tourist visas and also suspended the visa-on-arrival facility. It has also put embargoes on tourists from affected countries. The bigger blow to FII sentiments came from the US closing its doors to European visitors. That was much bigger because now the US doors are closed to visits from China and from Europe.
Don’t forget the role of Yes Bank
If you look at the FII selling in the last one month, the real trigger came from the moratorium on Yes Bank. The heaviest selling happened in the six trading sessions between March 06, 2020 and March 13, 2020. The RBI taking control of Yes Bank raises questions over the health and sustenance of other mid-sized banks. FIIs realize that when a bank gets into trouble, the collateral effect is always huge.
MSCI India premium over MSCI EM Index had scaled new highs
This is a critical factor driving FII flows. By late 2019, the premium of MSCI India P/E over the MSCI EM P/E had crossed 75%. That was last seen in the year 2008 ahead of the financial sector meltdown. With the valuation gap above the "Mean" (+/- 2SD) levels, it was a signal to sell since FIIIs can allocate across multiple markets.
Earnings fail to keep pace with prices
MSCI projects 4% growth in earnings for the EM index as a whole and 16.4% growth for MSCI India. This justifies a gap in valuation. The challenge is that sales growth in India has failed to keep pace. Also, it is doubtful what happens to profit growth once the impact of the corporate tax rate cut is factored in. This also triggered FII selling.
On the positive side, the weak oil prices have sharply brought down the CAD (current account deficit) and also the pressure on the rupee. That should eventually entice FIIs to get back into the markets; as has happened time and again in the past.