India fares better than EM peers in attracting FII funds this year despite high valuations

Despite premium valuations, India’s dollar-based returns over the past year lag behind those of markets like the U.S. and Taiwan, raising concerns about potential overheating.

Foreign institutional investors (FIIs) displayed a mixed outlook on emerging markets (EMs) in 2024, with notable capital outflows from major players like China and Brazil. In stark contrast, India managed to attract modest positive inflows, highlighting its resilience and appeal as a stable investment destination amidst global uncertainties.

India’s FII Inflows Stand Out Amid EM Challenges

Recent data reveals a significant divergence in capital flows: India saw small but positive FII inflows, while China, Brazil, and several other prominent EMs faced substantial capital outflows. Key reasons for this trend, according to analysts, include:

China’s Property Market Meltdown: The ongoing turmoil in China's property sector and broader economic challenges have raised alarm bells for investors. Concerns about growth, regulatory crackdowns, and the stability of major industries have led many FIIs to reassess their commitments to China, prompting a shift in focus towards more stable markets like India.

Macroeconomic Stability: India’s robust GDP growth projections and sound macroeconomic policies have enhanced its attractiveness. With controlled inflation and a stable monetary framework, India emerges as a relatively safe investment haven in a turbulent global environment.

The expansive consumer market and burgeoning middle class in India continue to lure foreign investors seeking long-term growth opportunities.

Investor Sentiment: The overall perception of India as a growth engine, coupled with the stability of its democratic framework, further strengthens its position. This sentiment contrasts sharply with the increasing unpredictability in China and Brazil, leading FIIs to favor India over other emerging markets.

Generally emerging markets (EMs) like India tend to attract more foreign money in a declining interest rate cycle, courtesy of a carry trade, which sees foreign institutional investors (FIIs) borrowing cheaper at home to invest in higher yielding, riskier EM assets, according to Andrew Holland, CEO, Avendus Capital Alternate Strategies.

High Valuations Remain a Concern for Indian Markets

While India has successfully attracted FII inflows, its market valuations are among the highest globally. Comparisons of year-to-date returns with forward P/E ratios reveal that India commands a significant premium compared to many of its EM counterparts.

One key distinction between India and other EMs is its economic structure. While many EMs depend heavily on manufacturing, commodities, and exports, India is primarily service-driven, with a stronger focus on consumption.

"This structure insulates India from the cyclical volatility affecting other EMs reliant on commodity exports," said Prashant Jain, Fund Manager and CIO- 3P Investment Managers. This unique composition not only reduces volatility but also leads to a higher return on equity (RoE), making Indian companies and markets more appealing to long-term investors.

As a result, India's premium is not overly concerning; however, it does raise questions about the relative attractiveness of other emerging markets.

Despite premium valuations, India’s dollar-based returns over the past year lag behind those of markets like the U.S. and Taiwan, raising concerns about potential overheating. Elevated valuations may lead to skepticism regarding sustainability, especially if corporate earnings growth fails to keep pace.

Investors might exercise caution regarding future returns from Indian equities unless earnings growth accelerates to validate the premium pricing.

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