2018 in review: Why foreign investors gave India a miss this year

The year 2018 will probably be remembered as the darkest for the foreign institutional investors (FIIs) in terms of ouflows from the Indian capital markets. The year which saw heightened volatility in the Indian market weakened the rationale for foreign investors to infuse their funds into Indian bourses.

Foreign investors were extremely bullish on the Indian market in 2017 and infused over Rs 2 lakh crore, the highest into Indian equity and debt markets during any calender year.

In 2017, Sensex gained 29.58% while the NSE Nifty rose 30.28%.

This year, foreign investors pulled out a record Rs 81,912 crore from the equity and debt segments of the Indian market.

The amount denotes the highest ever outflows by FIIs from the Indian market and their waning interest in the Indian growth story.

As the year comes to an end, the Sensex has logged over 4.79% gains and the Nifty has risen nearly 2.02% since the beginning of 2018. The gains are mediocre when compared to 2017.

A key factor deciding the Sensex, Nifty gains this year was the FII flows recorded for the Indian capital market.

Here's a look at factors why FIIs made a sudden exit out of Indian markets this year.

IL&FS crisis

Country's leading infrastructure finance company came under the scanner of multiple regulators, including Sebi, for alleged defaults related to financial disclosures and corporate governance in September this year.

The firm also defaulted on interest payments on commercial papers. Commercial paper is a key component of money-market mutual funds, which have surged in popularity in response to low bank deposit rates and persistent inflation. The group with 24 direct subsidiaries , 135 indirect subsdiaries, six joint ventures and four associate companies was reported to be sitting on  a debt of about Rs 91,000 crore.

The repayment crisis helped to raise borrowing costs in credit markets, with the average yield on one-year corporate notes jumping to the highest since 2015.

Analysts said banks'margins would come under pressure in a rising interest rate environment and higher credit costs on account of IL&FS exposure.

Higher borrowing costs led the markets lower especially NBFC and banking and auto stocks taking a hit.

This prompted FIIs to withdraw money from the  Indian markets.  In September, FIIs pulled out Rs 21,035 crore from the Indian market. The negative trend continued in October with FIIs taking out a record Rs 38,906 crore in order to minimise losses in their investments.

Federal Reserve rate hike

The US Federal Reserve raised key short-term interest rates four times this year. in response to a strong US economy and signaled that it expects to maintain a pace of gradual rate hikes.

A rate hike by Federal Reserve leads to a rise in US treasuries yield and acts as an incentive for foreign funds to park their money into the US markets since they will get higher returns for their investment.

This leads to foreign fund outflows from the Indian market as rate hike lowers investment returns for foreign investors and prompt them to sell.

Depreciation in rupee

The Indian rupee fell to an all-time low of 74.48 or 16.61% year-to-date on October 11 this year due to high crude oil prices and strengthening of the US dollar.  The rupee fall led to the erosion of value of FII holdings in dollar terms which prompted them to exit the Indian market.

Long-term capital gains tax

The Modi government imposed long-term capital gains tax on equities with effect from April 1 in Budget 2018-19 this year. The imposition of LTCG dealt a big blow to the funding plans of FIIs into the Indian market.  Continuing their winining streak from 2017, FIIs infused Rs 22,272 crore in January this year. The amount was the highest monthly infusion by foreign investors into the Indian market this calender year.

On February 1, the government announced  the imposition of LTCG tax on equities which hit investor sentiment. FIIs withdrew  Rs 11,674 crore from the Indian market in February. In March, investors poured Rs 2662 crore into the market but that was a shortlived respite for the indain bourses.

The LTCG tax which came into effect from April 1, 2018 led the foreign investors running for cover for three months.

Till June, foreign investors withdrew a huge Rs 61,132 crore  (April 15,561 cr, May 29,776 cr, and June 15,795 cr) from the Indian market hurt by the impact of LTCG tax on their investments.

Edited by Aseem Thapliyal