Will FII support continue in 2002?

S Vaidya Nathan

FOR the stock market, 2001 was a poor year with stock prices declining sharply. But inflows from foreign institutional investors (FIIs) were at levels reached only in the last decade. Net FII inflows for 2001 were around $ 2.85 billion.

In the 2001 third quarter, it appeared as if the 1996 high of $3.06 billion would be comfortably exceeded. But FIIs became active sellers in the last quarter and each month saw only modest inflows. As a result, 2001 would now only be the second best year in terms of net inflows from FIIs.

That such heavy inflows did not move the market up is what stands out. To a large extent, this was the trend the preceding two years as well, as the FIIs became more active traders. The rapid increase in FII purchases and sales had only a muted upside impact on stock prices. In sharp contrast, FII selling had a more pronounced impact on stock prices on the downside.

Where do such heavy inflows from FIIs leave them in terms of exposure to the Indian market? Instead of showing gains on their Indian exposures, the stock price decline in 2001 pushed the aggregate FII position to the red. The year also saw the exit of around 70 FIIs.

But what the FIIs appear to have done in 2001 is enhance their exposures in frontline stocks. There has been a decisive shift to large-cap, high-liquid stocks. To a large extent, this explains the firm trend in stocks such as HDFC, HDFC Bank, Grasim and Reliance among others. They also appear to have moved out of second-rung tech stocks.

In line with the global trend of paring exposures in technology/telecom stocks, FIIs appear to have done the same in India as well. The aggregate FII position has a more diversified look with the oil, petrochem and cement sectors becoming important holdings. A stock-wise break-up of FII exposures is not available. But the move towards such a trend is confirmed by a scrutiny of mutual funds with FII linkage. The portfolio of such funds as Alliance Capital, Morgan Stanley, Zurich India are more diversified with tech exposures pared by more than half.

In 2001, in line with the decline in stock prices, the FIIs' trading has seen much less than in the bull market of 2000. But their activity this year in the secondary market may be a more realistic indication of how they will operate. Even at the lower levels, the FII purchases and sales have been around Rs 100,000 crore - a big number by any yardstick. The FIIs have opted for a high level of trading operations and an active churning of portfolios, which have implications for investors in domestic mutual funds.

These funds were net sellers for much of the year. While FII net purchases were around Rs 13,250 crore, domestic mutual fund sold stocks upto Rs 2,500 crore.

With FII operations dwarfing domestic mutual funds in trading as well as in absolute terms (FII assets at around Rs 40,000 crore are 60 per cent higher than the equity assets of domestic mutual funds), investments in FII-linked mutual funds may be a better option. This could help investors capitalise on the broad direction of the fund flows.

The key question now is: Would 2002 be as good a year for FII flows as 2001? Given the downturn in the global economy and decline in stock prices in other markets, it is quite likely that FII flows will be considerably lower in 2002 compared to 2001.

The indifferent economic environment in India and the stress on global fund managers which have been pruning emerging market operations also point to such a possibility. That may be good news for the market outlook. But what may save the day from a further sharp decline is the pricing in most negatives at current price levels.