In a volatile market, domestic institutional investors to remain stabilisers
The environment for foreign institutional investors (FII) inflows will remain stressed in 1H2017 – before normalising in 2H – as key central bankers worldwide gradually move towards monetary policy normalisation and tighten liberal liquidity injection and policy rates.
Global bond yields have already begun to drift away from zero/negative bounds indicating that the traditional template for pricing asset worldwide, which was broken for a brief period in mid-2016, is being restored. However, this will imply that a significant chunk of funds of global asset allocators will gravitate towards US assets, primarily exerting pressure on capital flows for other countries, most markedly for emerging markets.
With rising US bond yields, the appreciating US dollar and an expected fiscal stimulus by the incoming Trump administration in the US, it is highly likely that both the capital flows and currencies of most emerging markets will be under pressure – the impact on commodity exporting emerging markets (EMs) may, however, be less intense than commodity importing EMs. In such a situation India in unlikely to stay insulated and accordingly FII flows are expected to remain volatile and subdued for Indian equities, particularly in 1H of CY2017.
With FII inflows likely to remain muted, domestic institutional investors (DIIs) will, for the third year in succession, remain the mainstay of institutional inflows for Indian equities. In the past two years, that is CY15 and CY16, DIIs have pumped in US$16bn into Indian equities, which is more than two-and-a-half times of the US$6.2bn of inflows from FIIs during the same period. This trend will be further entrenched in 2017 in the light of limited impediments to continuing equitisation of household savings.
The conventional lure of physical assets, that is gold and real estate, has already abated significantly over the past two years and is likely to stay muted in the foreseeable future as India transitions towards a less-cash economy, coupled with stringent regulatory scrutiny over the generation and circulation of unaccounted money, which is likely to dent investment demand for these two asset classes.
This implies that household savings will continue to incrementally move towards financial assets and with falling interest rates, households are likely to rely more on equity instruments to generate above-average returns.