Story of ‘hot money’

Foreign investors losing impact on Indian stock market?
Story of ‘hot money’
Representational ImagePxhere [Creative Commons]

Let me begin by reproducing a short story. Once upon a time, a man landed in a village. He announced to the villagers that he would buy dogs for Rs.50. Since the village was full of dogs, the villagers went out in every corner of the village and started catching the dogs.

The man bought hundreds at Rs.50, but, as the supply started to diminish, the villagers stopped their efforts. The man further announced that he would now buy at Rs.75. This renewed the efforts of the villagers and they started catching dogs again.

Soon the supply diminished even further and the villagers started returning to their own respective work. The man again revised the offer rate and increased it to Rs.100. The supply of dogs became so little that it was an effort to even see a dog, let alone catch it!

The man now announced that he would buy dogs at Rs.150! However, since he had to go to the city on some business, his assistant would now act as buyer, on his behalf. Now the assistant told the villagers: ‘ Look at all these dogs in the big cage that the man has collected.

I will sell them to you at Rs.100 and when he returns from the city, you can sell them back to him for Rs.150. The villagers squeezed together their savings and bought all the dogs.

Then they never saw the man or his assistant again, only dogs everywhere!

This story tells us how the Foreign Institutional Investors (FIIs) have been playing in the Indian stock market and have remained one of the main drivers of the markets.

They always remain in news, whether they enter the market or take an exit route by off-loading their holdings. If we peep into their performance in the stock market, we find their presence in the market directly impacts the investment decision of the domestic investors.

In a way, domestic investors, particularly the retail investors blindly follow the investment strategies of the FIIs. For instance, whenever FIIs bought, domestic investors also bought. Whenever they sold, domestic investors also sold. Precisely, FIIs flow into the Indian market, called ‘hot money’, carried both confidence and fear for the domestic investors.

However, over a period of time, the influence of FIIs has started diminishing. Unprecedentedly, they have been consistently selling Indian equities since October last. In this calendar year, they sold equities worth Rs.1,11,383 crore, according to NSDL. Interestingly, this time, FIIs intense selling has not impacted the Indian equity markets the way it used to.

Notably, this kind of ‘selling scenario’ was witnessed in the 2008 global financial crisis, when, according to a report, they sold equities worth Rs.52,987 crore. Amid the heavy selling of Indian equities by the FIIs, we have for the first time witnessed a reverse trend.

This time domestic investors are buying, when the FIIs are selling. In the words of market experts, the resilience in Indian equities hints at the changing texture of the share market where the exodus of FIIs is more than counter-balanced by domestic participants.

What is FDI and how is it different from FII and FPI?

Foreign Institutional Investors (FIIs) are those foreign investors who are directly investing in the productive assets of another nation. Foreign Institutional Investors (FIIs) are different from the foreign investors who take the FDI route to invest in another country. FIIs are single investors of a group of investors that brings in foreign portfolio investments. They invest in financial assets like the bonds and stocks of another country.

FPIs are the same as FIIs.

It is commonly believed that countries with a higher level of FPI or FII can easily encounter higher market volatility and turmoil with respect to currency during uncertain times.

It is mandatory for FPIs or FIIs to get themselves vetted and accredited by SEBI, the Securities and Exchange Board of India, to participate in the Indian stock market.

What are Participatory Notes?

Participatory Notes or P-Notes are offshore derivative instruments used by the foreign institutional investors for making investments in the Indian stock markets. They are issued by brokers and FIIs registered with SEBI and used outside India for making investments in shares listed in the Indian stock market.

The investment is made on behalf of these foreign investors by the already registered brokers in India. The brokers that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to SEBI for each quarter.

Investing through P-Notes is very simple and hence very popular amongst FIIs. To avoid going through scrutiny like know-your-customer norms etc., foreign investors take this route. Another advantage is that the end beneficiary of these notes is not disclosed and helps the investors to remain anonymous.

How do Participatory Notes work?

There are three stakeholders involved in completing this investment. The first is the investor, second is FII and third is a broker.

Indian FIIs are set up in different countries to help them invest in the Indian stock market. These FIIs need to have registered themselves with SEBI without which they aren’t eligible for being an FII or invest money in the Indian market.

Be it hedge funds or individuals, both have to contact these FIIs to invest in the Indian market. These FIIs make an investment on the behalf of hedge funds and high net worth individuals.

After this, the Indian brokers are supposed to report their participatory note issuance status to the regulatory board each quarter. These notes allow foreign investors to participate in the Indian markets without registering SEBI.

What is the current level of P-Notes in the Indian markets?

Remarkably, investments in the Indian capital market through participatory notes (P-notes) rose to Rs 89,143 crore till the end of February, with experts saying the positive trend is likely to continue in the coming months on expectations of strong corporate earnings by India Inc which will enthuse foreign investors.

Of the total Rs 89,143 crore invested through the route till February 2022, Rs 79,747 crore was invested in equities, Rs 9,224 crore in debt, and Rs 172 crore in hybrid securities.

At the end of December 2021, the investment level was Rs 95,501 crore.

What is the domestic investors’ scenario when foreign investors are pulling out from the Indian markets?

Even as the quick pull out of the FIIs has caused disturbances in the market, the domestic investors have held the market together in the past few months and averted a market crash.

During the two years of pandemic we have seen a huge rush of first-time investors board the market to try their hand in investment in equities. Millions of new retail domestic investors have been keeping the market abuzz with their hectic investment activities.

This has helped to mitigate the risk of any market crash during the currency of FIIs’ pull out.

Disclaimer: The views and opinions expressed in this article are the personal opinions of the author.

The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK

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