Are Indian equities hotting up for FPIs?

Indian equities could re-emerge as a draw for foreign portfolio investors (FPIs) on expectations of strong corporate performance and with interest rates plateauing after a brisk run-up. The spread between the stock earnings yield and bond yield is narrowing, which increases the attractiveness of investment in equities. Sluggish aggregate demand is expected to weigh on corporate revenues in the last quarter of 2022-23. But companies are likely to expand their margins due to declines in commodity prices. Beaten down stocks with healthy bottom lines offer a better alternative to bonds whose yields have come off recent peaks since the Reserve Bank of India (RBI) paused interest rate increases just ahead of headline inflation slipping below its tolerance threshold. The cap on credit costs should improve corporate profitability.

Foreign portfolio flows into Indian equities have reversed following a flight to safety when central bankers began synchronised global liquidity tightening. These are likely to grow stronger with emerging economies accelerating relative to advanced economies. Resumption of growth in China will, however, direct financial flows towards North Asia, dampening sentiment on Indian bourses. China is in an interest rate-cutting cycle, magnifying the pull for investment in its equity market. But the pace of its recovery is likely to be uneven as it struggles with domestic demand and a slowdown in international trade.

Financial flows will also be affected by the extent of deceleration in advanced economies. Stress exerted on the banking system by lower bond prices has led to the US Federal Reserve lowering the tempo of its rate hikes. A declining dollar provides some cushion to emerging market equities. Yet, the severity of an eventual US recession will have an outsized impact on Indian equities, given the concentration of services exports. The pace of India’s recovery is slowing down and global capital will be evaluating it against growth rates in China and the US. The case for equity bulls is not fully made yet.