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Podcast #26: Who moved my market? A deeper look at FIIs.



“Are FIIs big? Why do we make a big deal of them? The answer is if you think of the Indian market as a whole, today’s market cap of the stock market is Rs 112 lakh crores (1.5 trillion USD) or 112 trillion rupees. 112 lakh crores can be divided into half owned by promoters (either the government for PSU or people like Mukesh Ambani for Reliance Industries and so on). They own 50% of the market capitalization of Indian stocks. Of the remaining listed market cap – half is owned domestic retail and institutions like mutual funds and insurance companies and corporates. And everything else – half of the non-promoter/free-float is owned by foreign institutional investors. This is huge because it means 1/4th of our market is owned by FIIs – that’s roughly 26-27 lakh crores (400 billion USD).”

On today’s show, Shray and Deepak discuss FIIs (Foreign Institutional Investors). Who are they, how big are they, and what role do they play in our markets?


Shray Chandra: Hi Everyone and welcome to Episode 26 of the Capitalmind Podcast. It’s been about a month since we last spoke and what a month it’s been. We’ve had lockdowns, stock market crashes, stock market corrections and we’ve aged quite a bit in the last one month. Towards the end of our last podcast we were wondering if we would do the next one in our office or over zoom and prophetic words – we’re doing this on zoom this time.

So today’s episode is on FIIs or the folks who apparently crashed our market last month (March 2020). So Deepak, welcome and is it true? The rumors have it that FIIs brought down the Indian stock market in March and even though Indian domestic retail was buying at that time, FIIs overwhelmed them. Is this the case? How big are these FIIs? Who are they? Why do we care so much about them?

Deepak Shenoy: This is an interesting episode, we’ve got a 30% fall in March and if you look at the data and classify this data as domestic institutions vs. foreign institutions, the foreign institutional players (FIIs as we call them) have sold roughly Rs 60,000 crore (8 billion USD) in March alone in the Equity market and Rs 56,000 crore more in the Debt Markets. So Roughly 1,16,000 crores (1.16 lakh crore) has been sold in total in just March alone.

This is a fairly large sum – to give you context – this is the single largest month (calendar months) ever. By a factor of 2x in the equity markets. The last one was 20,000 crores in Oct 2018 and before that even the 2008 crisis – the sales by FIIs were only 14,000 crore in a month (Oct 2008). This has been a very steep fall with an extremely high (velocity?).

Are FIIs big? Why do we make a big deal of them? The answer is if you think of the Indian market as a whole, today’s market cap of the stock market is Rs 112 lakh crores (1.5 trillion USD) or 112 trillion rupees. 112 lakh crores can be divided into half owned by promoters (either the government for PSU or people like Mukesh Ambani for Reliance Industries and so on). They own 50% of the market capitalization of Indian stocks. Of the remaining listed market cap – half is owned domestic retail and institutions like mutual funds and insurance companies and corporates. And everything else – half of the non-promoter/free-float is owned by foreign institutional investors. This is huge because it means 1/4th of our market is owned by FIIs – that’s roughly 26-27 lakh crores (400 billion USD). 

This is a small part of global financial institutional holdings. Blackrock worldwide is an asset manager and manages roughly 7 trillion USD in assets. 400 billion is 5.5% of just Blackrock’s assets. All foreign institutional investors together own 5%  of what Blackrock manages worldwide. We’re small for them – they’re big for us. That’s why we care about them so much but perhaps they don’t care about us so much….but because they hold 1/4 th of the market of ½ of the non promoter float, obviously they do have an interest.

S: Fair enough. So, do you feel FIIs really were responsible for the crash and why do we have separate rules for them? Why do we look at them so closely, measure their transactions everyday? What’s behind our obsession?

D: Yes, I think they were responsible for the crash. If you look at the quantum of selling – Rs 61,000 crores – this is significant in comparison because any other player does not bring in or add this kind of money. A good month for mutual funds is Rs 6,000 – 8,000 crore inflows. That’s great! That much money from Indian investors into mutual funds, which then buy stocks would be a fantastic month. In that same month you see FIIs sell 60,000 crores – they overwhelm any domestic investment put in. FII sales caused a 30% fall. Worldwide, there has been a global liquidity crisis of a massive sort. One of the biggest problems that we’ve had (economically) is not really the corona virus impact but that bond markets, stock markets and home mortgage markets, commercial paper markets worldwide for frozen for a big part of March. Given the size of this equation (the corona virus had not even hit us at this time), yet the markets which were frozen caused a massive liquidity problem and worldwide we saw sales of equity to cover margin calls – One of the biggest sales that happened ever. The fall in the US (35% fall) within 2 weeks is the fastest even since 1929’s big crash. We haven’t seen carnage so fast worldwide ever. 

Similarly with India. This sucking out of money from equities has happened in such a way that you’ve seen about 8 – 8.5 billion dollars move out of Indian equities. This pales in comparison with the fact that 450 billion dollars of equity has been sold worldwide in the last 1 month. Effectively, we’re a small part of the world economy. We have 1-2% of world assets. A global mutual fund will have 1-2% of its assets in India. If you look at 450 billion of selling worldwide, 1-2% of that (roughly 8 billion) has indeed been sold in India. (percentage wise) we aren’t different from the west. People haven’t sold India vs the US (percentages are the same) – we’re in line with the selling in Europe, US as well.. 

The reason for this is that a lot of mutual fund/investment money into India has come through Index style investing. This is responsible for the fall, because when you sell to meet a margin call everything must go. You need to sell whatever is required to get in money. You don’t analyze the largest or best companies, you just sell whatever is available to sell. And you sell the HDFC Banks and the HDFCs – it doesn’t matter if it’s a good bank or bad bank or good company or bad company, you’re selling because it can be sold and the margin can be realized. Therefore you want to sell and exit these investments just to produce cash.

Given this, I personally believe that while FIIs have been responsible for a large part of the crash, it was a blind panic. Everything was sold for liquidity/margin reasons. All of this may not be permanently gone. We’ll come back to it in a moment. 

Now why we have separate rules for FIIs.

India for the largest time has been afraid of bringing in foreign investment. There are two reasons for this. One we think FIIs will come and gobble up Indian companies and will not give Indian investors a chance to participate. Foreigners will “own” our companies.

The other reason is that they feel that the FIIs will take out their money at the worst possible time and ruin our economy when they take their money out and cause a crisis. 

Both of these have precedents. In the 1970s foreign institutions were allowed invest in India as direct investments (Coca Cola as an example) but they were forced by George Fernandes to list locally and give out their equity at par to Indian investors and they said they won’t do that so Coke left the country and a few others continued like HUL and a bunch of others. These were Direct Investments, Strategic in Nature. They actually own the companies or operate the companies they invest in. This is FDI. This is similar to say Amazon or even the investments in Flipkart by Vcs are all called FDI. The investments in public markets are called Foreign Portfolio Investments (FPIs) or FIIs.

These were opened up slowly over periods of time after 1992  (?) when the markets really opened to FPIs keeping in mind there was this fear that these folks would gobble it up.

The other fear was that a lot of Indian companies (when India had 90% taxes in the 70s) had chosen not to pay taxes by moving money abroad somehow. A lot of promoters/large families would figure out how to keep money abroad. They would then become NRIs to not pay some taxes. These funds were now outside India, the promoters knew India well, so when India opened up, these funds would come back but since they couldn’t say these are my funds that I kept secretly abroad, they came in as entities owned by people who weren’t willing to disclose their true identiy. But this was FII and it came in from abroad – from say Mauritius. This FPI, we knew that some of it was round tripping, you would earn money in India, ship it abroad through hawala or something and then bring it back as FPI.

We’ve seen a number of cases where people have identified companies owned by Indian companies that are registered in Cayman and that have routed money back into India in different ways. There was a fear that if you promote these companies too much, then people would be encouraged to ship money abroad and then bring it back as an investment and participate in the Indian economy. 

There were rules set up to say – I need to know who you are. Initially, in 1992 when we asked for this – the funds said I’m not going to tell you. We needed the money badly so we said ok for a few years don’t tell us. So in 2007, more stringent rules were announced that said within 5 years if you need to tell us who you really are, if you’re a Mauritius fund then who your investors are, what their identity is etc. These rules were set up for making sure that this was not round-tripping and this was not people who were not allowed to invest in India and so on.

There were also rules on who can/cannot take out money. We’ve had currency controls for the longest time. An FPI who puts money in can take money out (whatever profits they make) so we need to know how much they invested and when and how much they’ve made in profits. 

India is special in the sense that we tax investment from abroad as Indian income. Which means, if you come in and buy shares and make a 10% profit then you pay taxes on that 10% profit in India. 

This is not the same case if you and I were to invest in the US. If you bought Amazon stock and made a 10% profit, that profit would be profitable in India but not in the US (unless you’re a tax resident in the US).

This is not the same in India. Even if you’re a non resident of India and are investing in Indian companies then you have to pay Indian taxes. This is unique. A lot of FIIs came and said why are you doing this – no other country does this. I’m taxed in my home country – why should I pay tax here? My home country will tax me anyway. India went and did a bunch of tax treaties to avoid double taxation. They also made a deal with Mauritius – a small country – and said any investment coming from Mauritius will not have any capital gains in India. Mauritius took this rule and asked foreign companies to come there, register shell companies and get investment from the US, UK and use that as a vehicle to invest in Indian companies. This was done for VC companies, for companies that were doing FII investments into India simply because we didn’t apply taxes on Mauritius funds. If you came directly from the US, you would be taxed. So the US FPIs which come in directly are taxed on the profits they make but folks who come from Mauritius would not be taxed. This was stopped in 2019 when rules were changed. 

In order to tax companies coming from Mauritius, incremental investments made after 2019 are at par with investments made by Indian retail investors. You pay the same 15% tax on short term gains and 10% on long term gains. This has allowed a slightly more even playing field. But it brings back the earlier question why every other country does not charge us, why does India charge us. These rules were set up with all this (background) context in place. 

A lot of the rules are around currency fears. People will take out money and our currency will weaken. Or they’ll become too powerful by owning too much. We have sector specific rules as well, with limits on how much you can own in a given sector. We did this to prevent them from owning too many of our companies but look –  they already do!

S: If we have so many restrictions and hoops that we want Foreign investors to jump through before they can invest in India and before they can take money out, why are they so interested in India in the first place?

D: This is quite a surprise for me as well. What happens is that – India is an attractive destination because of its size. We have a billion people, one of the larger economies in the world, we’re growing per capita income, not yet at the level where we can say it’s booming but definitely it’s one of the better developing countries.

Having said that we’re still small in the world context. Our whole market size is 112 lakh crores (1.5 trillion USD) in comparison the US market cap is probably 15-20 trillion dollars in the equity markets alone (note: google searches after the podcast show 30 trillion). We have single companies in the US that are valued as much as India’s entire market. Amazon valued at a trillion dollars. In effect, India is small but is too big to be ignored. So every investor has this concept where they want to asset allocate and have a presence in everything. It may not be a big presence and that’s why India doesn’t get a big allocation. A 100 billion dollar fund will put say 5% of its assets in emerging markets –  that’s 5 billion dollars. Within emerging markets I’ll put 20% in China and 10% in India and 5% in South Africa – so 10% of that 5 billion dollars = 500 million dollars then comes to India from that one fund alone. That’s 3,500 crores that comes to India from that one fund’s tiny 0.5% overall India allocation.

Similarly, a lot of such funds exit, we have an emerging market ETF called EEM. It’s an FPI from our perspective but they invest in a lot of emerging markets, MSCI has made an index called the Emerging Markets Index of which 8% is allocated to Indian companies, 27% to China, some from Korea etc. A fund called EEM which is a blackrock ishares fund which invests in emerging markets is an 80 billion dollar fund. 8% of 80 billion is roughly $ 6.5 billion. 6.5 billion USD in Indian Rupees is about 45,000 crores. To give you context, if this was an Indian mutual fund – it would be the second largest mutual fund in the country. The top Mutual Fund is SBI Index ETF which is about 60,000 crores, the second is Kotak Standard Multicap which is about 28,000 crores. Roughly this will be India’s second largest mutual fund, this is only an 8% allocation of an emerging market ETF which is also a small fund compared to most of the other large mutual funds in the world. So we are getting a very small allocation of a large pool which simply wants a toehold in India.

You can’t ignore India – even an actively managed fund thinks if India goes up 50% I can’t go and tell my investors that I don’t have any investments in India. I would rather say I had some money and since it’s doing well now I’ll add more next quarter. This is another way for you to hedge your bets. Your investors will be unhappy if you don’t have investment in a country that is doing well. 

Now here’s the thing we’re not doing well. How badly? We’re at the same levels (in USD Terms) if you had put your money in 2007 in the Sensex. You would have a 0% return in 13 years. It’s that bad in terms of returns. But ignoring the returns, people have invested and one of the reasons is simply because you had to allocate to multiple countries and you can’t ignore India.

There’s another more sinister but interesting reason. As I said some of these FPIs are Indian promoters with money abroad. And that money has now come back through NRI or friend/family routes. One of the things that happens when such investment comes back is that it comes back to India because the promoters know India best. They know the times when it’s right to invest, maybe not in their own companies but also in other companies. They can use these foreign funds as a vehicle to invest instead of using their own names in India because they won’t ask questions of this FPI but they will ask why promoter X is buying a particular stock if they had bought it in their own name. This applies to anybody in India as well, using the cloak of an FPI is useful to a lot of people and sometimes that is also the reason why FPIs continue to invest in India despite not having great dollar adjusted returns.

S: Let’s revisit, why do you think FIIs took out so much money from India, you mentioned they needed liquidity and have they done something like this before or was this a once in a multi-decade event?

D: This time the liquidity situation across the world was horrible. They took out money despite no fundamental backing. There was no reason why an HDFC bank should fall 30% while some of the stocks which have no debt at all have also fallen 30-35%. It’s almost like saying we took everything out it and that makes sense in the context of a criss where people have simply invested in say an ETF which has invested through an indexing approach and they are exiting simply because the requirement of money was so strong that you simply need to exit and get whatever you can. If that is the context that any liquidity crisis worldwide would have caused such blind exits in India. This has happened in the past – when was the last time we say an exit from debt at high levels? 

This time was an exit from both stocks and debt. Last time we say this was Aug 2013 when we say Rs 31,000 crore exit from debt in one month alone. This last month was Rs 56,000 crore exit from debt. What happened was the taper tantrum. Which means that in the US, the QE that was done had been used to justify the market’s high pricing. At one point the Fed literally said – you know what, we may be considering not printing more money. Not even that they were taking money out but to say that they were not going to print any more money, which was a tapering of money. That tapering itself, the fear of a taper itself caused money to exit from assets worldwide. Rajan had to come to India and calm waters and the US Fed also calmed everyone down. That took a few months. That time we did see a massive liquidity exit from India in stocks, stocks fell about 20-25% and I remember the time distinctly because this was just before I started Capitalmind as a full fledged company. The fear that time was palpable – how much more money will they or can they take out?

The crisis before that was 2008. That’s when we saw a massive liquidity crisis because of what happened with Lehman Brothers. It wasn’t a huge amount of money (14,000 crores in Oct 2008) but that money was a similar percentage as March 2020. If you look at how much FIIs have invested since 2007. From 2007 to now the total FII investment is roughly 7 lakh crores which has grown to 25 lakh crores in value (haven’t made any profits in dollar terms, invested over time, not all at once). If you compare 61,000 crores as a percentage of the total (8-9%) and even at that time 14,000 crores was roughly the same percentage of the total amount of money invested then.

We saw a similar amount of money go out and a similar amount of carnage. We saw 28% drop, the whole year was a wash (50% down). This time we’re seeing a 35% drop. Last time a Rupee and Dollar change accompanied this. In 2008, the rupee depreciated 20%, in 2013 it went from 55 to 68 (20%). This time it’s only gone from 71 to 76 which is less than 10%. 

This has happened before, I don’t know if it will continue to happen but obviously we will look at this from the perspective of India being more tuned into global liquidity. It is rare that FIIs decide to exit only India and not others. That hasn’t really happened in any meaningful way. It may be small pockets where FIIs got scared. In 2007 when India asked FPIs to tell us who you really are, that’s when they said Sell Now and they sold so harshly that the stock markets hit their down/lower circuit during what was an otherwise bullish period. There was one day in 2007 when only India crashed. Foreign Investors said don’t do this all of a sudden. It was then clarified that these rules would only be introduced after 5 years. That’s when they came down and the market came back up. Then the markets hit new highs within a month (so the episode was forgotten) despite the near 10% fall in 1 day. We’ve seen more global liquidity issues having an impact on the Indian FII exits.

S: Coming back to our initial question, if FIIs are so large and their liquidity moving in/out can make such a difference to Indian markets, are our fears/apprehensions around FIIs justified? Do you think that they deserve to have these restrictions put on them, should we continue to monitor them as closely as they do right now. Will they come and take over everything?

D: This again has history. For instance the fears of FIIs coming in and taking their money out at  the most inopportune times, this has history in the Asian Economic crisis when foreign investors were given a free hand to invest in Thailand, Indonesia, Malaysia and their economies crashed after the crisis because foreign investors shorted their currencies and George Soros had made this incredible bet that they would depreciate. Currencies fell by something absurd (100%?) but India took an outside view because we weren’t that open at that time so we decided that we’re not going to allow this short term money. Even now FIIs are not allowed to invest easily in short term debt. It’s easier than earlier when it was completely banned but it’s still something that requires applications. 

I don’t think this fear is justified. If I don’t allow you to fire people, will you ever hire people? If you can’t leave/will you enter in the first place? Free markets have an attraction because of freedom itself. At some points the efficiency of markets is such that when RBI cuts rates the markets fall, even the debt markets go up – it’s almost the opposite of what’s written in text books where if one country cuts rates people should exit from that country and put it in another country with a higher rate. In reality more money comes into India after the rate cuts because our rates are high in the first place so bringing them down makes for lower default risk from high interest rates. 

A lot of the rules are to say “at least we did something”. It’s not about being useful for the FIIs or the economy but the fear that they will exit any time and at the worst possible time make our currency weak. Even with these rules, the FIIs exited at an inopportune time for the currency anyway. There is no protection against that. If we allow more freedom, every time they’ve done that they have come in much bigger and provided protection to our currency. That’s why we’re a lot more free than we were in 2008 or even 2013 that’s why our currency has weakened a lot less. RBI was active both times to support the rupee.

About owning our companies, FIIs already own half of the free float. Apart from this, some companies have FII promoters. Maruti has Suzuki as a promoter, Sanofi has Sanofi worldwide, Abbot has Abbot Pharma in the US. You’ve got HUL which has  Unilever PLC – these are all companies where the promoter itself is not an FPI or FII – it’s called FDI. Therefore they don’t even show up in this 25% number. 1/4th of the market is owned by FPI/FII and another portion is owned by FDI. FDI and FPI together own a lot of our largest banks – HDFC Bank, HDFC and to  some extent Kotak have large Foreign ownership. Domestic ownership is relatively smaller. ICICI Bank or HDFC – you could nearly call them foreign companies, more than 50% is owned by foreign investors.

With all these rules, we have all this fear that when the Bank of China buys 1% of HDFC we feel violated even though most of HDFC is already owned by forigen money. When you think of Flipkart you think  of it as an Indian company but most of the shareholding was abroad, Flipkart India was owned by Flipkart Singapore and so Flipkart wasn’t really an Indian company. It was mostly owned by Singapore. A lot of companies that you think of as Indian today because they are managed/promoted by Indians have significant foreign ownership. This is not a problem because management is perhaps more important than control. You can’t have a generic rule that foreigners cannot own all companies outright or that they can’t own anything. We have to find the right fit in the rules. Our rules are more strenuous than the west but the fear that they will own more and wipe us all out – well if it’s real then this has already happened.

S: A Bit Ominous. Let’s look forward – we’re not sure which countries will do best when it comes to dealing with the Coronavirus. Let’s say that developed economies recover faster or slower than India (relatively) – what does that mean for FIIs and the Indian stock market. Should we secretly be rooting for the western economy to be doing better or worse from a stock market point of view?

D: The west seems to have reached certain numbers but India is behind that, so the west may recover first. The west has seen significant stimulus both fiscal and monetary. So the Fed is printing money and the liquidity crisis which happened has resulted in large exits of capital from India – along the western economies. 

To counter this, the Fed has decided to print unlimited amounts of money. The Fed today is buying commercial paper. Now typically central banks give banks money and banks go and do their stuff. Now banks aren’t doing their stuff so now Feds are saying we’ll buy bonds – government, corporate, Commercial Paper, mortgage, anything you throw at us we’ll buy because we can print unlimited amounts of money. 

This is not uncommon, the Swiss National Bank once held 4% of Apple. They printed money in Swiss Francs, converted into dollars and went and bought Apple stock. Central banks owning everything is not unheard of. The Japanese central bank owns 70% of the Japanese ETF market. 

The massive scale of this is that more than 5 trillion USD has been printed/will be printec in a few weeks. USD 5 trillion+ has been committed. Apart from that there’s more than 600 billion in Euro/german stimulus and more stimulus to come in Europe and the EU. We’re talking of very large sums of money. 5 trillion dollars as a figure (and I think it’ll be more) If you say that 1% of that comes to India that’s 50 billion dollars. What we saw go out of India is 8 billion dollars in equity and 6 billion in debt. Even if you add this up that’s 14 billion dollars which went out. With all this printing if 1% of this comes to India then 50 billion coming – that’s nearly 4x what went out.

What’s going to happen to a market where daily trades are 55,000 crores, where 60,000 crores on exit caused a 30% fall – how is that going to react to a sum of 50 billion dollars (380,000 crores) coming in? It may happen over the next 6-8 months but even if that kind of money comes in that would be a ludicrously high number – given the fact that there’s no equivalent seller of securities at that level, all this is going to do is take prices up. When the market goes up more money will be invested. This is just the way that markets are and people look at markets. Markets tend to track momentum. This 50 billion dollars is known. It’s going to raise our markets to substantial levels. When you buy bonds from people who are unable to sell them, people get money and now they’re safe. A few weeks later, they’re like – what do I do with this money? Buy bonds again? But I can’t buy bonds anymore because the Fed has made interest rates zero or close to it. All the safe assets have been bought by the Fed. People who have money and want to make gains, will invest in something more risky. That something more risky is equity. When it comes to us, it will come party through that.

On the fiscal side you give people money because they are out of jobs and sitting at home, in India people are spending substantially less. Even if you give a stimulus, a lot of stimulus recipients will be (relatively) rich. The rich people will take stimulus money and invest it and not spend it because there isn’t enough to spend on. They’ll invest this money in the stock market and will result in asset prices going up.

Whatever enmity we have towards FIIs will become extreme friendship because they will come back with more and bigger pockets next time. However, there is a warning to be given. As much as we saw this, we realize that foreign equity investors caused a 30% fall by taking out 2%-3% of their money in India. Taking out such a small percent of their money has resulted in a large crash. If they come in with even more money, that’s going to make them an even bigger holder of Indian stocks and when the next crisis hits we’re going to see an even bigger problem. At some level, there is not enough of a balance. Either India has to get rich enough fast enough so that we can be a bigger participant in our own markets or we have to be ready for such large crashes to happen more frequently and more likely in the future.

S: So we do care about what the Fed and ECB do but we have to be wary of the effect. So thanks a  lot for that Deepak. I’ll hand it back to you. Thanks Everyone for listening!

D: Yes, lovely to talk. I hope all of you are safe. Wash your hands and also remember you can get to us at @capitalmind_in on twitter and @deepakshenoy. We’re also available at where we write about this stuff in more detail with charts. You can subscribe to Premium where our Slack Channel will give you a lot of these inputs in real time with talks/discussions/webinars. If you want to invest money with us we have Capitalmind Wealth ( our SEBI registered Portfolio Management Service – we have ways to invest in both India and the US through some of our strategies and goals. So we would love to speak more about this with you! Thanks and do get in touch!


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