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FII vs DII – Can DIIs replace FIIs in India

Economies like India, which offer relatively higher growth than the developed economies, have gained popularity as attractive investment destinations for foreign institutional investors (FIIs). Investors are optimistic on India and sentiments are favorable following the government’s announcement of a series of reform measures. FII’s net investments in Indian equities and debt have grown at a tremendous pace, backed by expectations of an economic recovery, falling interest rates and improving earnings outlook.

Money invested by foreign institutional investors (FII), is often called ‘hot money’ because they can be pulled out at any time, and they have been blamed for large and concerted withdrawals of capital from the country. For instance in 2008, they withdrew more than Rs. 13.50 bn from the market. But they are still considered as a major driver for the equity markets in India, thanks to their size of investments which they have put into the domestic asset classes

Since India runs a current account deficit, we need capital inflows which can be in the form of either FPI or FDI. While we would prefer FDI since it is less volatile in nature, though a second choice, FII inflows are welcome as well, despite their more volatile nature.

On the other hand, domestic institutional investors (DII) tend to support the markets when FIIs withdraw capital like in the year 2018, where FIIs sold more than Rs. 340 bn while DIIs remained net buyers of more than Rs. 1090 bn. Indian equity markets have outperformed emerging markets by 26% in USD terms in the last four years since the Narendra Modi-led National Democratic Alliance (NDA) government came to power. DIIs have also invested more than FIIs over the last four years where they have pumped huge investments into the Indian equities

Year FII (in Bn) DII (in Bn)
2014 973.50 -303.21
2015 183.55 675.56
2016 187.83 371.12
2017 528.85 908.35
2018 -341.62 1093.67
Total 1532.11 2745.49

The amount generated by DII brings us to the question whether DIIs can replace FIIs in the coming years and can it become the next major driver for the markets.

At the current juncture, though DIIs are pumping huge amount of money into the domestic equities, still they cannot absorb the foreign inflows in the near to medium term as they have invested more than Rs. 8000 bn since year 2000. Though mutual funds are definitely gaining clout, they are far from matching the might of foreign institutional flows. The comfort is that they support the market and provide a cushion when the market falls and they have been buying stocks at lower prices in every dip. DIIs can surpass the impact of FIIs but it could be possible over a period of time when the size of their investment grows further.

As far as DIIs are concerned, the domestic savings mostly flow into mutual fund investments. The trend towards financial savings was already visible in the last few years. Indians are increasingly investing in financial assets as compared to physical assets such as gold and real estate. As per the RBI data, physical savings declined by Rs. 180 bn, whereas financial savings rose by Rs. 2140 bn, both from FY2013-14 and FY2016-17.

Households generate about 55% of all savings. Historically, the bulk of those savings are locked in unproductive physical assets rather than being deployed in growth generating financial assets. The flows of the savings after demonetization and lack of other asset classes with better returns prompted robust inflows into equities. Traditional alternatives such as real estate, gold or even fixed incomes are not showing attractive returns, unlike equities. This is the main reason why SIP inflow is showing resilience.

We believe that household savings will be increasingly invested in financial assets and any setback in this trend in case of extreme volatility in financial markets will be temporary. It has been articulated that India has witnessed investments of $1 bn in Systematic Investment Plan (SIP) alone. We have reached the stage where DIIs have been pumping in $10-12 bn each year merely from mutual funds. DIIs might continue investing in the months to come as inflow of SIP and pension money is still strong. Habit of investing into equities is expected to strengthen in India and mutual funds and insurance companies are likely to get high inflow of money in the next 5-10 years. On the other hand, DII’s inflow may become slower if the equities starts underperforming in comparison with the other asset classes, while if the employment rate in India doesn’t improve, then the flows through SIPs may not see any significant jump which in turn will affect the liquidity from the domestic investors.

Year Life Insurance Fund Provident and Pension Fund Shares & Debentures
2011-12 1,956.73 956.8 165.22
2012-13 1,799.49 1,564.79 170.27
2013-14 2,044.69 1,778.41 189.3
2014-15 2,993.22 1,908.83 203.64
2015-16 2,699.60 2,917.42 448.93
2016-17 3,491.98 3,020.10 362.65
2017-18 3,272.33 3,496.54 1,509.48

Source: RBI


Equities as % of household wealth


On the other hand, India’s equity markets are expected to get a new endorsement from the nation’s pension regulator as well. Government employees contribute about 87% of the Rs. 2.3 tn ($35 billion) overseen by the NPS, which started in 2004 and later opened to all citizens for voluntary contributions. The National Pension Scheme may well get an added advantage over other investment options if the government agrees to increase the equity proportion for government employees as well. The government is reportedly considering giving its nod to invest up to 75% of the NPS funds in stock markets followed by allowing employees with higher salaries to route 25% of their PF contribution into stocks, while retaining the 15% cap for low-income employees. Coupled with it, insurance is growing around 10-15%. These are sources of long term capital, where inflows are less volatile than mutual funds.

In a nutshell, the flow of money within the domestic circuit is likely to remain certain as merely parking money in savings bank accounts and in fixed deposits is no more enticing enough for investors. Hence, we expect that if GDP and income levels grow, domestic flows in the market are likely to remain intact and possibly grow as well. To conclude, we expect DIIs to become the counterbalance for FIIs in the coming years as flows from the households, pension funds, mutual funds and SIPs are expected to increase as savings and tax planning is expected to rise. While it will take a few years to be the driver for the market but definitely DIIs will have a good hold on the Indian equities.

Rajiv Singh

CEO – Stock Broking, Karvy

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