Introduction
Any country’s economic development is fueled by a well-regulated financial industry. The world is looking to emerging nations for a greater return on investment after liberalising economic rules and globalizing the asset market. This anticipation of better returns encourages capital flow into emerging financial markets, not just from foreign investments but also from domestic investments. With the global economy touching bottoms, it becomes very important to take a glance at the Indian economy relative to other major economies. As the volatility in the Indian Stock Market persists, the sentiment change in FPIs and DIIs is imperative to study.
The present Indian Stock Market
The biggest pull-out of Foreign Portfolio Investors (FPIs) of Rs. 201, 500 crore (as on May 30th, 2022) is a major negative hit in the history of Indian Stock Market. In India, the reasons for FPIs pull-out can be related to the increased tax surcharge. The implementation of buyback tax is also seen to be a driver for this exit. However, predominantly, this began since October 2021 as a result of global inflation. Accelerated by the Russia-Ukraine conflict, rising bond yields in the US, apprehension of recession in the US, an appreciating dollar, aggressive sudden tightening of the monetary policies, relatively high prices in India, and a whopping hike in global commodity prices, particularly crude oil are factors behind FPIs pull out. The FPI inflows cause stock market indices to rise, while their outflow causes market indices to fall. Thus, the selling of FPIs brings about large changes in the market by resulting in an increase in the volatility. Volatility is one of the most crucial factors in investment decisions. It is defined as a degree of price variation during a particular period. Along with the FPIs, the Domestic Institutional Investors (DIIs) also play a key role in the monopoly of the market. Banks, Insurance companies and mutual funds are some of the DIIs which mobilize funds into the Stock Market. If the FPIs react aggressively by selling out then DIIs can bring the volatility down and stabilize the market. The recent rigorous selling by the FPIs was offset by the buying from DIIs who have tremendously increased their holding in 72 percent of Nifty50 companies. The study of influence of FPIs and DIIs in the domestic market is of great importance from the perspective of policymaker for monitoring of systemic risk for India in particular and other markets of countries in general.
The big worry: Inflation
The major economies of the world like US and the Europe are presently witnessing continuous rise in inflation, as a result of which, the central banks have started tightening the monetary policies and hiking the interest rates. The US Consumer Price Index (CPI) inflation is recorded to be at around 8.3% in April and that of the Europe, the annual inflation reached 8.1%.In the recent data released by the National Statistical Office, retail inflation in India as measured by Consumer Price Index rose to an eight year high of 7.8 percent. With this increase in inflation in global economy, a sharp sell-off in financial markets has been witnessed across worldwide.
RBI’s fight with Inflation
Section 45-ZA of RBI Act, 1934 stipulates that with the consultation of the Reserve Bank of India, the Central Government shall determine the inflation target in terms of Consumer Price Index (CPI), once in every five years. Accordingly, in a notification on March 31, 2021, the Central Government, in consultation with the RBI, retained the inflation target at 4% (with upper tolerance level of 6 per cent and the lower tolerance level of 2 per cent) for five year period April 1, 2021 to March 31, 2026. Entering the sixth straight month where the inflation has come in above the upper threshold of RBI’s inflation targeting framework, clearly signals the failure of central bank’s fall behind the curve when it comes to managing inflation. In its monthly meeting on June 8th,, the RBI raised the repo rate by 40 basis points to 4.90%. Moreover, The RBI has been giving further signals of an increase in the repo rate in the next quarter. Repo rate is the rate at which RBI lends money to the commercial banks. As a move to cool the inflation, the central bank increases the repo rate acting as a disincentive for commercial banks and making borrowing for them stricter. This leads to controlling the money supply in the economy, thereby clenching the inflation. Inflation is majorly being driven in the present time by global food and commodity prices.
How can high repo rate slow down Inflation?
Firstly, high repo rate lowers the expectations of future inflation. This can be done by alleviating the current inflation further by pushing the demand. This would not be feasible for the market of India. However, it can be done efficiently in the developed and emerging markets. Secondly, higher interest rates attracts foreign capital which helps in appreciating the currency, which is again not the case for the present market in India as the rupee is touching new levels of depreciation each day. For this to work in India, it would require massive rate hikes, given the regulations by US Fed. Thirdly, the most appropriate outcome can be achieved by curbing the credit growth which can be done by raising the cost of borrowing as well as its availability. The question still stands rigid because of the small real credit growth which is running around 2 % presently in India.
The relationship between Repo Rates and Stock Market and its impact on DIIs Investment
There is an adverse relationship between repo rates and stock market. With every change in the repo rate made by the RBI, an impact on stock markets is established. A cut in the interest rate makes the inflow of cash in the market prominent, whereas, a hike in the repo rate makes the companies and DIIs cut their spending on expansion and thus this curbs the growth of the market as it affects the cash inflow and thus the prices of the stocks fall. However, given the hike in interest rates, huge volatility in the global stock market as well as domestic stock market and sustained selling by FPIs, equity mutual funds has managed to attract inflow of Rs. 18, 529 crores in May as against Rs. 15, 890 crores inflow in April 2022. Inflows through Systematic Investment Plans (SIPs) rose to Rs. 12, 286 crore in May, 2022 from Rs. 11, 863 crore in April, 2022. This is the ninth consecutive month where SIP inflow is seen to be greater than Rs. 10, 000 Cr, following September, 2021.
The promising Indian Economy
Since the present economic condition desperately awaits the further rise in repo rate, the exponential exit of the FPIs from the Indian Stock Market is also something which cannot be overlooked. As increase in repo rates results in more saving and less spending therefore resulting in the lower cash inflow in the economy, however, the RBI’s move to increase the repo rate further with an intend to fight inflation has not restricted the DII investment in the Indian Stock Market. This portrays the trust of the retail investors in equity investments. This advancement has been seen to stem from the fact that the narrative of Indian economy’s growth stands to be positive and promising in comparison to other economies of the world. The GDP forecast is anticipated to be at 7.2% and thus this has brought a positive sentiment in the investors.
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