Do not mistake it for signs of reversal, say experts as FII selling slows in February

The cumulative selling activity of foreign institutional investors in February may well have slowed when compared to January but experts believe that there are no signs to show that the selling trend is reversing soon. In February, FIIs were net sellers at nearly $4 billion in India's secondary markets, a decline from the $9 billion sold in January.

Indian markets witnessed a sharp selloff in February, with the benchmark Sensex and Nifty dropping 5.6 percent and 5.9 percent, respectively. Broader markets faced even steeper declines, as the BSE MidCap fell over 10.5 percent and the SmallCap index plunged 14 percent.

Incidentally, FIIs remained net buyers in primary markets, investing around $824.99 million in February, up from $448.70 million in January.

Even as investors eagerly await the return of FIIs, analysts hold mixed views. Some highlight the stronger appeal of markets like the US and China, while India's weak corporate earnings dampen near-term FII inflows despite improved valuations. Others argue that FII selling is reluctant and driven by liquidity concerns rather than a fundamental shift in sentiment.

Rajesh Palviya, analyst at Axis Securities, attributed lower FII selling in February to fewer trading days rather than a reduction in selling momentum. He believes FIIs are maintaining their recent selling trend, with no immediate trigger for a shift in stance despite the market correction.

While oversold markets may see a technical pullback, he does not expect FIIs to drive this rebound. He noted that slowing economic growth, weak earnings, and high valuations have already been factored into the selling. The key driver for continued outflows, he added, is the availability of attractive, risk-free returns in markets like the U.S., prompting FIIs to reallocate funds away from India.

A recent Kotak report stated that strong foreign investor participation in its conference wasn’t driven by immediate buying interest but rather by a desire to understand India better for future opportunities. Investors indicated they were preparing to enter the market if a meaningful correction occurred or if their EM fund inflows increased.

Some acknowledged being underweight on India for a while, with the recent correction validating their stance. However, they now see long-term value emerging in large-cap sectors like financial services, real estate, and e-commerce/QSR.

EM fund managers expressed optimism about inflows into emerging markets later this year due to the widening valuation gap with US equities. However, India isn’t their top priority given slowing growth and high valuations. Additionally, India’s capital gains tax has become a growing concern, particularly as return expectations have dropped compared to past years when equities delivered 20 percent+ returns and INR/USD remained stable.

Deven Choksey, MD of DRChoksey FinServ, attributed the FII outflows to the need for dollar fund withdrawals from emerging markets, including India. He also pointed to the rupee's weakness against the dollar, which has driven leveraged funds to exit. However, he believes that the bulk of leveraged selling has already taken place.

Fundamentally, Choksey sees India as strong, with Nifty’s one-year forward PE at around 18x, making valuations attractive. He expects a recovery-led bounce in the markets. He also noted that FII selling had a significant impact due to weak market liquidity, suggesting that with better liquidity, the outflows would have had a much smaller effect.Siddarth Bhamre, Research Head at Asit C Mehta Investment Intermediates, believes the bulk of FII selling has already occurred, and while selling may continue, its intensity is likely to reduce. He attributes this to the correction in US bond yields and India's significant underperformance globally. Bhamre remains cautious on the market but expects incremental FII selling to ease as valuations become more attractive. On the timing of FII buying, he suggests that once domestic investors start selling, FIIs may re-enter the market.