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FPI flows and inflation trajectory implying peak QT cycle in CY23 despite hawkish US Fed; domestic inflows remain structural

* Trend of FPI flows since H2CY22 implies peak QT cycle environment could be approaching in CY23 (refer Chart 1). Despite hawkish comments by US Federal Reserve during its Dec’22 FOMC meet, US and India bond yields have remained stable at ~3.7% and 7.3%, respectively. Also, FPI flows towards India and other EMs continued to be relatively stable even after the hawkish stance which indicates market expectations of peak interest rates in CY23.

* Inflation trajectory for both US and India have undershot expectations in the latest readings for Nov’22 with commodity prices continuing to be subdued in Dec’22 and shelter costs dipping further in the US. Also, we will be entering a period of significantly favourable base effect in Q1CY23 due to the commodity price shock seen last year post the Russia-Ukraine conflict when crude prices spiked above the US$120/bbl levels along with other commodities.

* Reversal of FPI outflows in H2CY22 has resulted in FPI holding of Indian stocks forming a bottom at 17% and now climbing up to 17.3% in Nov’22 (refer Chart 5)

* Domestic flows continue their positive trend and, in our view, have passed the litmus test of extreme events over the past one year (omicron wave, unprecedented QT cycle in terms of jumbo rate hikes, Russia-Ukraine conflict driven risk-off environment and resultant spell of commodity price shock). The monthly SIP (systematic investment plan) flows into MF schemes have touched alltime high of Rs133bn.

* Worries on financing of CAD reduce as FDI inflows continue to be robust while FPI selling reverses (refer Chart 11). Forex reserves have started to rise and have hit US$564bn in Dec’22.

Risk – Going ahead, incremental sharp outflows from EMs like India could emerge if the current expectation of terminal interest rate of ~5% for US is breached on the upside along with slowing economic growth expectations. Upside revision to the US Fed’s dot plot seen post the Dec’22 FOMC meet highlights the above risk. However, going by the current inflation trajectory which undershot expectations, the likelihood of terminal rate rising further remains low in our view.

Sectoral level institutional flows in H2CY22 so far

* Using the final FPI flows data from NSDL, which includes primary inflows as well, inflows from FPIs stand at US$11.8bn so far in H2FY22 till 16th Dec’22.

* FPI buying in H2CY22 (till 30th Nov’22) has been driven by domestic economy sectors such as financials, consumer discretionary, industrials, FMCG, healthcare and telecom (refer Chart 7). However, sectors driven by global factors such as energy and IT were sold by FPIs.

* Consequently, aggregate FPI equity assets stood at Rs49.9trn as of 30th Nov 2022, which translates into 17.3% holding of aggregate listed Indian equities (Rs288.5trn).

* In H2CY22 till 16th Dec’22, DII buying had moderated to US$3.9bn whereas within DIIs, MF buying had moderated to US$4.4bn.

* MF buying in H2CY22 (till 30th Nov’22) has been the highest in auto, consumer discretionary, healthcare and financials sectors while metals, telecom and IT sectors have seen outflows.

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