Reason for FII Outflows and Inflows

If you’re an avid stock market investor, you must have dealt with market volatility several times. However, do you know what causes this volatility? There can be many factors ranging from geopolitical situations to domestic economic developments. One factor that often causes market turbulence is FII outflows or inflows.

FIIs play a major role in driving the Indian stock markets. They hold significant stakes in some of the leading Indian companies and hence, their investment activities impact the Indian stock exchanges to a remarkable extent. If you’re wondering what FIIs are and what causes FII outflows and inflows, read this article.

What are FIIs?

FII’s or Foreign Institutional Investors are large organisations or institutions that invest in the shares of companies belonging to some other country than the one where these organisations are based. FIIs are usually large financial companies, such as banks, asset management companies, etc.

They invest significant amounts in Indian securities to generate better returns. Hence, these FIIs play a major role in controlling the Indian stock markets. When FIIs increase their investments, it is known as FII inflow. Whereas, when they withdraw or decrease their investment in Indian securities, it is known as FII outflow.

Impact of FII flows on Indian stock markets

As mentioned, FII outflows and inflows can impact the Indian markets in several ways. A sudden influx of investment or FII inflows may boost the market sentiments and cause an increase in the stock index or prices of selected stocks. Such a development can bring temporary bull runs in the market.

On the other hand, sudden withdrawals or FII outflows may decrease the Indian stock market index and cause temporary bear runs. Most of the time, FII activities are the primary causes behind unexpected market volatility.

Apart from this, FIIs also contribute to maintain market efficiency. FII inflows also provide stability to India’s fiscal deficit and balance of payment. Here’s how FIIs outflow or inflow impacts the economy:

Inflows

• ensures a healthy flow of equity capital and hence, strengthens market sentiments and aids the financial and economic development of a developing country

Outflow

• can hurt markets’ sentiment and hence, cause a temporary fall in the market
• can also lead to a slowdown in the domestic market due to the reduced capital strength

What causes FII outflows and inflows?

Several reasons can be responsible for FII outflows or inflows. To understand this better, let’s segregate the common causes for FII outflows and inflows.

Here’s why FIIs usually pull out from Indian markets:

• Strengthening of the foreign currency

When foreign currency starts to gain value against the Indian rupee, FIIs look to liquidate their investments in Indian securities to save their returns due to a fall in INR. However, they might return with their investments once the value of the rupee settles down.

• Tighter monetary policies

A change in their domestic policies can also force the FIIs to pull out their investments in foreign securities. For example, with the Bank of England and the U.S. Federal Reserve reducing bond purchases and tightening liquidity in the market, FIIs may look to liquidate their investments in Indian markets to shift their capital base to high yielding debt market in their country.

• A rise in the inflation rate

Central banks across the world, including the Reserve Bank of India (RBI), increase their lending rates whenever there is a rise in the inflation rate. As a result, companies start feeling the heat, which causes FIIs to pull out their money.

Now, let’s learn about the reasons that cause FII inflows:

• Global liquidity

Global liquidity is the exact opposite of the third point mentioned above. When the inflation rate across the world falls, global liquidity increases. As a result, central banks reduce their lending rates, which lures the FIIs to invest in emerging markets like India to get better returns.

• Macro environment

The positive macro environment of the Indian market also causes FII inflows. When the economy is booming, and the markets are going strong, FIIs start to invest larger amounts in developing markets like India.

The Bottom Line

FII outflows and inflows can severely impact the market.  However, most of the time, the impact is temporary, and it should not deter domestic investors from investing in the stock markets. While FII investments are highly regulated by the Securities and Exchange Board of India (SEBI) and the RBI, it may affect the market sentiments to an extent because of a large inflow or outflow.

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