FIIs pulling out of India is not a surprise. But where is their money going?

The short answer: Apart from China, it was South Korea, Japan and Indonesia. These three markets alone attracted foreign investments of over $18.5 billion so far in 2024, according to data from Dezerv as of 21 October.

FPIs offloaded Indian equities worth a net $8.48 billion from October 1 to 17, data from the National Securities Depository Ltd showed. In early October, the global market chatter was all about China.

The moment China unveiled stimulus measures and economic prospects brightened, foreign investors rushed into Chinese equities, swiftly redirecting capital away from India and Japan, noted Rupen Rajguru, head of equity investment and strategy at Julius Baer India.

Weekly inflows into emerging markets were about $40 billion in the second week of October, he said. Of this, a staggering $39 billion poured into China, largely from emerging market funds and directly into Chinese assets.

During this period, there was an outflow of about $3.5 billion from Indian equities, while Japanese stocks registered a record outflow of $9 billion, he said.

However, weakness in the yen has encouraged foreign investors to boost their purchases of Japanese stocks, said Vaibhav Porwal, co-founder of Dezerv. The yen posted its biggest decline against the dollar following Prime Minister Shigeru Ishiba’s remarks in early October, which calmed concerns about future rate hikes.

Why investors are shifting

What’s particularly interesting is that alongside China, the South Korean and Indonesian markets also attracted inflows, hinting at a broader shift in investor sentiment towards the Asian markets.

Taiwan’s TSEC Weighted Index led the pack of gains in Asia with a 30% year-to-date rise, followed by Hong Kong’s Hang Seng, which climbed 22%. Japan’s Nikkei 225 was up 14%, while the Nifty 50 rose 13%, and China’s Shanghai Composite gained 12%. Indonesia’s Jakarta Stock Exchange posted a 7% return during the same period. However, South Korea’s Kospi stands out with a negative return of 2%.

Many experts said the FPI outflow from India is likely temporary, driven by two factors: profit-taking after a stellar rally and investors finding more attractive markets. Against this backdrop, India’s long-term growth narrative still positions it as an attractive long-term investment bet. However, FIIs are currently seeking alternative opportunities in light of high valuations and more favourable returns elsewhere.

Porwal of Dezerv explained that potential returns are closely tied to timing, as they depend on entering and exiting the market at the right valuation. When entry valuations are elevated, the potential for returns diminishes.

“Currently, Indian equities are trading at higher valuations (PE at 24.2x) compared to markets like Indonesia, Taiwan, and South Korea, trading at 18.6x, 23.7x and 13.4x, respectively,” said Porwal.

“Southeast Asian markets like Indonesia and Vietnam are also attracting interest due to their strong economic fundamentals and lower valuations,” pointed out Vipul Bhowar, senior director of listed investments at Waterfield Advisors. He added that the strong FPI inflows into Indonesia and South Korea could be attributed to their favourable valuations compared to India, and sectoral strengths, particularly in technology.

Souvik Saha, an investment strategist at DSP Asset Managers, said the MSCI India Index has pulled back by about 6% from its peak largely due to heavy selling by FIIs.

“This marks the fourth-largest selloff in India’s history in absolute terms,” he noted, adding that large-cap stocks had the steepest decline from peak to trough across all categories of market capitalisation.

Softening earnings

What’s really weighing on investor sentiment for India is the potential for earnings softening in the near term and the risk of an economic slowdown heightened by goods and services tax collections hitting a four-month low in September. Central and state governments mopped up ₹1.73 trillion in GST last month.

India’s manufacturing activity eased to an eight-month low in September, according to the HSBC final India Manufacturing Purchasing Managers Index compiled by S&P Global.

All this is when other global markets look more appealing with their high growth prospects and relatively moderate valuations, Saha explained.

As per a Goldman Sachs report dated 18 October, “Of the 18 MSCI India companies that have reported results so far, 11 have missed consensus estimates. Misses are broad-based across sectors.”

Another factor driving the outflow is foreign investors rebalancing their portfolios.

“As the year-end approaches, FPIs review their portfolios to ensure alignment with their investment strategies and risk profiles. So, they may sell off well-performing assets to maintain a balanced allocation across different asset classes, leading to a rebalancing of India’s overweight allocation in most strategies,” said Bhowar.

Pankaj Singh, smallcase manager and founder and principal researcher at SmartWealth.ai, noted that there is a shift in global investor interest towards emerging equity markets that are proving to be competitive alternatives to both India and China.

Singh said most FPIs focus on present and potential returns rather than valuations while investing.

“If market A offers returns above 5% and market B offers less, FPIs will gravitate towards market A and steadily increase their exposure,” he explained.

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