Indian stocks were the third-worst performers among leading emerging markets in September as foreign portfolio investors pulled money out of the country at the fastest pace since November last year amid a slide in the rupee.
Market participants said foreigners shifted money from the expensively valued domestic shares to cheaper destinations on worries that corporate earnings growth will take time to revive.
Repeated comments by the US Federal Reserve on normalisation of monetary policy have also affected sentiment in emerging markets, such as India, with high foreign holdings.
The Sensex fell 1.4% during the month while Nifty lost 1.3%. If not for the strong inflows of over Rs 20,000 crore by domestic institutions — mutual funds and insurers — during the month, losses would have been bigger. Foreign portfolio investors pulled out close to Rs 13,400 crore in September.
This includes Friday's provisional figure of Rs 1,547 crore worth of selling by foreign investors and Rs 2,065 crore of buying by domestic institutional investors.
Taiwan and South Africa, which fell 2.4% and 2.7% respectively in September, were worse off than India. Brazil, Thailand, Philippines and South Korea advanced 1.3%-3.9%. The near-term market direction will depend on foreign fund flows.
"FII (foreign institutional investor) outflows will continue. Generally, they are pulling out money from EMs (emerging markets) in response to normalisation of policy by the Fed and in expectation that ECB (European Central Bank) could also look at tapering when it meets in October," said Abhay Laijawala, head of research at Deutsche Equities India.
Foreign investors have sold Indian shares for the second month in a row in September.
They dumped equities worth Rs 12,600 crore in August. In the past, foreign fund selloffs of this magnitude have resulted in steep falls in the market.
But this time around, domestic institutions have cushioned the fall, armed as they are with funds pumped in by retail investors who are shifting from fixed deposits, real estate and gold to equities. In August, domestic institutions bought stocks worth Rs 16,200 crore.
Since January, domestic institutional investors have pumped in Rs 63,215 crore. In the current calendar year, foreign investors remain net buyers of shares worth about Rs 32,300 crore, even after their selling spree in August and September.
India remains overweight for overseas investors, but they would rather wait for some positive triggers before allocating incremental money, experts said.
"From a long-term perspective, investors are positive on reforms and the country's prospects. However, in the near term, they believe markets can be volatile as the economy rebalances following rapid rollout of transformational reforms," said Laijawala. Share valuations are offering no comfort to investors either, said analysts.
The Sensex is trading at roughly 20 times earnings estimates for the current financial year compared with 14 times for the MSCI Emerging Market Index. "After the strong 20% rally year to date, valuations are a tad demanding.
Also, earnings estimates continue to be revised down. At the start of the fiscal year, the street was expecting 20% earnings growth (for FY18), but now the expectation stands reduced to 14%," said Bharat Iyer, head of India equity research at JPMorgan.
Iyer cautioned the earnings growth number could be lower still. So far in 2017, Indian indices have been among the best performers in emerging markets. The Nifty is up 19.6% since January while the Sensex is up 17.5%. "For foreign investors to put incremental money to work, there should either be a pullback in the markets or earnings should recover," said Iyer.
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