Will Moody's downgrade result in more FII outflows?

FIIs have YTD sold Rs.612 billion, but the latest negative rating might hurt investor sentiment again

Published a month ago on Jun 05, 2020 Read
Anoop Bhaskar, Head-equities, IDFC MF
Equities are always forward looking, while debt is backward, in the sense that it rewards areas that have seen an improvement, not those that will improve in the future. Hence, the rating outlook does not matter for equity now. Given that the market has fallen substantially from its high and now that consensus is looking at a recovery in earnings growth in FY22, we are looking at buoyancy on the Street. In the past as well, there has been no co-relation between downgrades and FII flows. In fact, India had started seeing outflows three to six months ago before the downgrade. In comparison to other Asian markets, we were seen expensive given our growth was slowing down. Almost all strategists reduced their weightage to India in their Asia portfolios between October and December last year. One of the concerns now is that almost 50% of FII investment in India is in the financial sector and the downgrade reflects the stress in the financial sector. That is why we have seen financials going through a massive selloff in the recent months. Going ahead, I do not expect further outflows. In fact, since May, foreign investors have turned positive, investing Rs.278 billion in Indian stocks.
UR Bhat, Director, Dalton Capital Advisors
Equity investors tend to take higher levels of risk as their return expectation is much higher as compared to, for example,  fixed income investors. For instance, an overseas investor considering an exposure to India would currently expect a 7-9% p.a. return from corporate bonds, but a 15-20% p.a. return on equities. Over the past 90 plus years, the US market has given an average return of around 10% p.a. So, a foreign investor who seeks to invest in Indian equities on a fully hedged basis, needs to generate around a 15-20% return, which includes hedging cost of around 3 to 5% p.a. When they are anyway assuming a high-risk stance while entering the Indian equity market, the marginal difference owing to the recent credit downgrade doesn’t really move the risk needle. But as things stand today, in terms of earnings growth, FY21 appears to be a virtual washout, given the expected economic consequences of the Covid-related lockdown. Any earnings revival is likely only from FY22. With possibly around six months of stunted production and most fixed, as also some variable costs to pay during the period, the financially weaker companies will find it difficult to survive. They will either go down under or get bought out by stronger companies, who will gain market share and possibly some pricing power.
Though we have seen some block deals by FIIs in recent times, a clear picture on which way the wind will blow will be clear only post the first quarter results. Further, credit ratings matter to debt investors because it decides the premium they will receive over the benchmark rates. When it comes to India, there is no sovereign borrowing internationally, but there are borrowings by  quasi-sovereign state-owned companies such as ONGC and some more,  by the private sector. Hence, the downgrade will lead to higher borrowing costs for these borrowers. Even though India is still in the investment grade, the more cautious investors may look to pull back as they fear India could fall below the investment grade in the next downturn.