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Posted by: Uma Shashikant and Labdhi Mehta on Wed, Jan 7th, 2015

FII flows and market returns over the last 10 years

January is the month when investors ask whether the FIIs have begun to come in, or if there would be a healthy flow of global funds into the stock market. It is therefore a good time to ask how FIIs have behaved in the past. Pic 1 shows FII inflows (net) into Indian equity and debt markets over the last 10 years.


Pic 1: FII flows and Market Returns

FII flows and Market Returns


There are at least two strands to the FII flow story.  The first one is about FII money being “hot” and the second is about it being “smart”.


The hot money idea is that FIIs flee when markets fall. This seems to be somewhat true with negative flows in the two bad years of 2008 and 2011.   But we may get the causality wrong here actually the markets corrected because the FIIs left and not vice versa.  It can be safely said that low equity market returns and negative FII flows have occurred together twice over the last 10 years.


If the FII flows were smart, they would ideally come in before a good year, or increase as a good year rolls in.  There is weak evidence of both events. 2006 was a better year in terms of equity return, but net inflows from FIIs sharply increased in 2007 after the event.  The spectacular return in 2009 might have contributed to the nearly $30bn inflow in 2010, but that year turned out to be an average one for the equity markets, followed by a negative year in 2011.  The inflows since 2011 have been lower than the peak of $25 billion, despite the market itself moving higher.  It does seem that markets move up with FII money coming in, as is well known, but the inflows themselves pick up only after markets have moved up. It may therefore wrong to assume that the FII flows and market returns are actually linearly related, and that higher inflows indicate a possible higher return. 


In reality, there is a combination of push and pull factors at play. The relative attractiveness of the Indian markets as an investment destination is one part of the story; the availability and willingness of global liquidity to flow into emerging markets is the other part. The former depends on how India looks, compared to other emerging markets competing for FII investment. The latter depends on the returns from developed markets and the interest rates.  If developed markets post higher return, global investors may prefer them, over risky emerging markets.  The growth rates in developed economies is a mixed bag – US is looking up; other are not. These stories are likely to become important in 2015.


There is also an interesting story brewing in the debt markets.  This channel for FIIs was only gradually widened in terms of ease of investing, over a period of time. Sub-limits were merged in 2014 and limits were set at the level of two broad categories created – government securities ($25 billion) and corporate bonds ($50 billion). Debt inflows have been increasing since 2010, but faced their first test in 2013. The exodus in that year was triggered by the depreciating rupee, and led to a sharp increase in interest rates by RBI.  Calendar year 2014 began with that cautionary background.  Would the deficit in the balance of payments reduce? Would the rupee stop depreciating? Would inflation fall? Would RBI reduce interest rates? 


2014 marked the first year when debt flows surpassed the equity flows, despite a good performance by the equity markets, indicating that the debt market flows may have finally come into their own.  The surprise crash in international crude prices helped the debt market yields. Crude prices are down to a low of $54 from $110 in January 2014. So did the lower inflation rate and the appreciating rupee. The WPI came down to 0% at the end of 2014 from the 6.4% in January. The year ended with the anticipation that RBI would reduce interest rates in the next calendar year. The 10 year is at 7.8% down from 8.8% at the beginning of 2014


Will the FIIs come in 2015 is the question being asked at this time.  It is very well known that many of them are already overweight India due to the outperformance of Indian equity markets compared to the other emerging markets.  The earning numbers for Indian companies have not yet come in as strong as expected.  The government is trying its best to keep the fiscal deficit at the budget estimate of 4.1%.  All eyes are on RBI, which is being persuaded to reduce interest rates.


At this time, it would seem as the numbers point out, that the balance is tilted in favour of debt rather than equity.  We will return to this story when the year ends and we have new numbers and new stories to tell.

pradeep pardeshi on Sat, Jan 24th, 2015 2:04:18 pm

Thanks Madam for this informative article

Bhagyashree Joglekar on Mon, Jan 12th, 2015 2:27:14 pm

An eyeopener, the general perception is that since equities have given very good returns in the past few months,FIIs are higher on equities than then debt,in reality it is just the opposite.Thank you, madam for this posting.

Chandan Hande on Sat, Jan 10th, 2015 2:30:27 am

As a retail Indian Investor this story inspires me to allocate long term funds into Equity(100%) by End of Jan 2015

Venkataramana on Fri, Jan 9th, 2015 10:21:03 pm

Good observation madam with comprehensive data.One things needs to know is that FII outflow brings in negative returns and it is high time indian (institutional and large no of retail)investors start investing in the capital market to avoid future shock as the global markets are uncertain and equity being the best asset class beating inflation is well known in the long run.. Hope the government and Not for Profit Organization takes necessary steps to bring in capital money through new innovative schemes and education across the country !!

VINODBHAI VADVALA on Fri, Jan 9th, 2015 2:52:16 pm

JAY SHREE KRISNA Very nice informative Thanking You GOD BLESS YOU

DEEP on Fri, Jan 9th, 2015 7:25:39 am

very nice and informative article madam.

Ramasubramanian on Fri, Jan 9th, 2015 4:31:27 am

RBI is nudging corporates to approach Bond markets for working capital rather than depending on Banking system. Hence Bond markets will improve in terms of volume and quality instruments. Coupon on bonds will stabilise may be over about 1% over the 10 year gilts.

krishna kishor tiwari on Thu, Jan 8th, 2015 9:22:14 pm

with stable govt.& positive attitude we are going to grow.US economy is also on growth path.we are hopeful for overall economic recovery.Europe & Japan are making efforts to stimulate there economies.India growth story is intact with new govt.inflow from FIIs in equity may cotinue in2015.

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