FPI Inflows Dip to ₹7,320 Crore in August: High Valuations and Global Shifts Trigger Market Sell-Off

Foreign Portfolio Investors (FPIs) continued to invest in Indian equities for the third month in a row, but the inflows slowed down in August due to both domestic and global factors. FPIs had been consistent buyers in June and July as the Indian markets stabilized after election-related concerns. However, they pulled back on their buying as the new fiscal year 2024-25 (FY25) began.

In August, FPIs invested ₹7,320 crore in Indian stocks, with net investments reaching ₹25,493 crore by August 30, according to data from the National Securities Depository Ltd (NSDL). In the debt markets, their investments stood at ₹17,960 crore for the month.

1. High Valuation of the Indian Stock Market

One of the main reasons for the slowdown in FPI inflows is the high valuation of the Indian stock market. Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, pointed out that “Nifty is now trading at over 20 times the estimated earnings for FY25, making India the most expensive market globally.” FPIs see better opportunities in cheaper markets and are therefore shifting their focus away from India. Vaibhav Porwal, Co-founder of Dezerv, echoed this sentiment, saying that high valuations in the Indian equity market have made Foreign Institutional Investors (FIIs) more cautious.

2. Unwinding of Yen

Another factor impacting FPI behaviour is the unwinding of the Yen carry trade, which occurred on August 24. This was triggered by the Bank of Japan Governor Kazuo Ueda’s hawkish comments during the July monetary policy meeting. Speculators unwound their Yen carry trades, leading to a stronger Yen and significant sell-offs in Indian equities. The Yen carry trade involves borrowing Japan’s low-cost currency to invest in countries with higher yields, but the recent developments caused investors to retreat from this strategy.

3. US Fed Rate Cut Bets

The unwinding of the Yen was accompanied by growing fears of a potential recession in the U.S. and disappointing economic data, which worsened market reactions. Despite U.S. Federal Reserve Chairman Jerome Powell hinting at upcoming rate cuts and expressing confidence in avoiding a recession, market analysts believe FPI flows will remain volatile due to these high expectations for rate cuts. Historically, rate cuts in the U.S. have not been favourable for U.S. equity markets, leading analysts to predict that FIIs will focus on emerging markets with more attractive valuations, though India may not benefit significantly from these flows.

4. Tax Changes in Union Budget 2024

Changes in the tax structure announced in the Union Budget 2024 have also played a role in the slowdown of FPI inflows. The increase in capital gains tax and the removal of the indexation benefit have raised the tax burden for investors. Additionally, the hike in the Securities Transaction Tax (STT) for futures and options (F&O) trades is expected to reduce liquidity and make hedging more expensive. FPIs are now likely to prioritize sectors that benefit from domestic reforms and growth, such as technology and infrastructure, while approaching sectors vulnerable to global downturns with caution.

5. Shift to Debt Instruments

FPIs are increasingly investing in the debt market due to the stability of the Indian Rupee (INR) this year, which is expected to continue. Dr. V K Vijayakumar noted that the strong buying trend in debt instruments among FIIs can be attributed to India’s inclusion in JP Morgan’s Emerging Market government bond indices earlier this year. Analysts also highlighted that the recent hike in capital gains tax on equity investments has prompted FPIs to shift their funds towards safer debt instruments. The inclusion in global bond indices, attractive interest rates, stable economic growth, and a favourable long-term outlook have been key factors driving FPIs to invest in debt.

When Will FPI Inflows Resume?

Analysts expect the selling trend to continue since India remains the most expensive market in the world, making it rational for FPIs to sell here and move their investments to cheaper markets. However, some interest from FPIs may persist in September, influenced by factors like domestic political stability, economic indicators, global interest rate movements, market valuations, sectoral preferences, and the attractiveness of the debt market.