Expert Explains Why FIIs Are Not Investing in India: Foreign Institutional Investors (FIIs) have been scaling back their investments in Indian markets, a trend that has caused significant concern amid ongoing market volatility. The BSE Sensex and NSE Nifty experienced declines, marking the eighth consecutive session of losses on February 14. Industry experts have been pointing to currency fluctuations and the impact of taxes as critical factors behind this cautious approach. Rajat Sharma, the founder of Sana Securities, explains that these financial elements reduce the returns for FIIs, making India less appealing to foreign investors.
The Decline in FIIs Investments: A Key Concern for Indian Markets
India’s stock markets have faced significant challenges recently, with foreign investors selling off large amounts of equity. On February 14, the Sensex dropped by nearly 200 points, reflecting a broader trend of retreat from Indian equities. This comes as FIIs have offloaded billions of rupees worth of stocks, signaling uncertainty about the attractiveness of India’s investment climate.
Experts believe that currency exchange rates and taxation policies are central to this declining interest. Rajat Sharma’s analysis sheds light on the mechanics of how currency volatility and long-term capital gains (LTCG) tax erode profits for FIIs.
Currency Fluctuations: The Hidden Risk for FIIs
A major factor affecting FIIs‘ decisions to reduce their investments in India is the volatility of the Indian Rupee against major global currencies, particularly the US Dollar. According to Rajat Sharma, when foreign investors convert US dollars into Indian rupees, they are exposed to exchange rate risks that can significantly impact their returns.
Sharma offers an example to explain this phenomenon: “Imagine you convert $1 into rupees at an exchange rate of 84 per dollar. After making a 10% profit, your investment grows to Rs. 92.4. But when you sell and repatriate your money, you have to pay the long-term capital gains tax (LTCG), which amounts to Rs. 1.05. In the process of converting back into dollars, if the exchange rate changes to 88, your return reduces to just $1.04. In this scenario, a 10% profit translates to only a 4% return in dollar terms.”
This scenario highlights how currency fluctuations reduce the overall returns for foreign investors. These hidden risks make investing in India less attractive compared to other markets where such uncertainties are lower.
The Impact of Long-Term Capital Gains Tax (LTCG)
Along with currency risks, the LTCG tax imposed by the Indian government further reduces the appeal of the Indian stock market to foreign investors. Introduced in 2018, the LTCG tax is levied on profits exceeding Rs. 1 lakh earned from the sale of equity assets held for over one year. While the intention behind the tax was to curb speculation and attract long-term investments, it has raised concerns among foreign investors.
For FIIs, the tax adds an additional layer of complexity and financial burden, diminishing the overall returns they can earn from Indian markets. The impact is particularly significant when coupled with currency depreciation, which together diminish the potential profitability of investments in India.
Ongoing Market Volatility and Investor Sentiment
The Indian equity market has seen significant volatility over recent weeks, contributing to a cautious stance by foreign investors. The Sensex, for example, has fallen by over 2,600 points in just eight trading sessions, reflecting a broader lack of confidence in market stability. The Nifty index also saw a decline of over 800 points during the same period.
Market analysts attribute this downturn to a combination of factors, including weak corporate earnings, particularly in mid- and small-cap segments. Moreover, external factors such as tariffs, depreciation of the rupee, and ongoing concerns over India’s trade relationships have kept investor sentiment low.
Vinod Nair, Head of Research at Geojit Financial Services, emphasizes that “Risk-averse sentiment continues to dominate investors’ minds as corporate earnings have fallen significantly below expectations, particularly in the mid- and small-cap segments.” This, combined with ongoing concerns about the depreciation of the Indian rupee and uncertain trade dynamics, has led many FIIs to reassess their positions in Indian equities.
The Broader Context: India’s Trade Relationship with the US
While domestic issues have played a central role in the cautious approach of foreign investors, international factors also contribute to the current market situation. In particular, India’s evolving trade relationship with the United States is a key area of focus.
India and the US recently committed to doubling bilateral trade to $500 billion by 2030, a move that is expected to impact the economic landscape significantly. As part of this commitment, Prime Minister Narendra Modi and US President Joe Biden have announced plans to negotiate a multi-sector bilateral trade agreement by 2025 to improve market access and reduce duties. This agreement aims to reduce trade barriers, potentially benefiting foreign investors by enhancing market prospects.
However, the uncertainty surrounding the details of these negotiations and the impact on tariffs remains a point of concern for foreign investors. The delay in finalizing these trade agreements is keeping many FIIs on the sidelines, further contributing to market instability.
Conclusion
Foreign Institutional Investors have been pulling back from the Indian stock market, and the reasons behind this trend are becoming increasingly clear. Currency fluctuations and the LTCG tax have significantly reduced the returns for FIIs, making Indian markets less attractive compared to other global options. Coupled with weak corporate earnings and ongoing market volatility, these factors are prompting FIIs to reconsider their investment strategies.
As the Indian government works to address these challenges and seeks to strengthen its trade relationships, particularly with the US, there is hope that the investment climate may improve. However, until these uncertainties are resolved, foreign investors are likely to remain cautious, and market volatility is expected to continue.
For investors, it remains essential to stay informed about these developments and to seek guidance from financial experts before making any decisions regarding investments in India.
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