Will FIIs return to buy Indian equities? US Fed rate pause to benefit India but outlook cautious

Benchmark NSE Nifty 50 and BSE Sensex saw decent gains on November 2 in response to the US Federal Reserve’s continued interest rate pause, reversing the correction seen last week. Will this prompt the return of FIIs, who have been sellers over the past three months, to Indian capital markets?

The dovish commentary by the US Federal Reserve and its chair Jerome Powell acted as a significant tailwind for Indian markets, which have recently faced rising Treasury yields, spiking crude prices and geopolitical tensions.

The market interpreted Fed Chief Jerome Powell’s statement as a mildly dovish signal — “even though inflation is high, long-term inflation expectations remain stable”. As a result, Treasury yields fell sharply while equity markets gained, since experts projected that the US Fed has reached the end of its rate hike cycle.

What does this mean for Indian equities?

The Indian stock market saw a decent rise on November 2, with the frontline indices rising around one percent intraday. Vinit Bolinjkarr of Ventura Securities said that if the American economy doesn’t offer enticing interest rates, then the smart money will move to emerging markets for higher returns.

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“This is very bullish for the Indian markets because any drop in the interest rates means that more money will flow into EMs and India will be the biggest beneficiary,” he added.

However, the long-term view remains cautious, according to Omkar Kamtekar, research analyst, Bonanza Portfolio. The rationale behind the caution is the strong resilience shown by the US economy growing ahead of expectations, heightened geopolitical tension and uncertainty in the Middle Eastern region coupled with the impact of the upcoming state elections in India.

“Additionally, the rates remaining higher for a prolonged period could aggravate fears of recession leading to increased volatility,” he added.

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FII comeback?

Since August, FIIs have been on a selling spree, offloading equities worth Rs 76,369.42 crore.

The immediate impact of the dovish tone was seen on the US 10-year bond yield, which slumped to 4.719 percent from 4.926 percent. The DXY has also retracted marginally and will further soften, according to analysts.

“This would prompt the return of FIIs to emerging markets with India being the preferred destination. Therefore, there is a window of opportunity for the FPI investors to buy into Indian equities as we have corrected from all-time high levels,” said Kamtekar.

However, there is a distinction in the type of FIIs. The ones using active strategies have retained their bullishness on India and will have steady inflows over the long term, said Naveen Kulkarni, chief investment officer, Axis Securities PMS.

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The passive strategies flow is influenced by the Federal Reserve’s stance, as it can lead to risk-off and risk-on situations. The current stance seems primarily neutral, and hence, flows are likely to be mildly positive over the next 6 to 12 months, added Kulkarni.

Stock and sectoral impact

FIIs have been consistently positive on the financial services sector, which received the most inflows over the past few months. With the revival in private capex, capital goods and infrastructure segments are seeing buying interest. “Therefore, select affordable housing finance companies, NBFCs that are outperforming banks, road construction and city infrastructure names would be preferred choices,” said Kamtekar.

India might see a further improvement in valuations once it is included in the global bond index next year. This will lead to cyclicals, infrastructure, manufacturing, defence, and railways sectors doing exceedingly well, leading to further inflows into these stocks, according to Bolinjkarr.

From the valuation and growth perspective, leading banks provide good buying opportunities. IT can stage a comeback, believes V K Vijayakumar, chief investment strategist at Geojit Financial Services, as interest rates are likely to see a cut in the coming year.

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