Equity investments by foreign institutional investors (FIIs) in the first four trading sessions this month touched Rs 2,440 crore or Rs 154 crore less than Rs 2,594 crore put by them in February, according to the data released by the regulator, Securities and Exchange Board of India (Sebi).
The trend since December 2013 showed a significant drop in equity investments and a surge in FII debt investments.
FII investments for December 2013 stood at Rs 15,614 crore and negative Rs 142 crore for January 2014, while in debt, the figure has risen from Rs 5,290 crore to Rs 12,609 crore in the same period.
For February, the net debt investments were Rs 11,337 crore, and in the first three trading sessions of March they were Rs 1,931 crore.
Barring January 2014, the rupee has gained strength against the US dollar from Rs 61.80 to the current level of Rs 61.12. Market players attribute this primarily to the shift in FII investments to debt that, in turn, led to the increased demand for the Indian currency owing to the interest rate differential.
Simply put, most FIIs have borrowed money in US markets at sub-50 bps; hedged their currency exposure in the forward domestic currency markets; and then invested in Indian short dated securities to make decent return of 1.25-2% annualised.
The six-month forward dollar premium currently hovers around 6.2% annualised and with the borrowing costs of funds for FIIs being less than 50 bps in US, the cost of funds, including forward cover when converted to local currency, at maximum would be 6.75%. If these funds are deployed in near zero-risk Indian debts of 8-9% yields, the net return still works out upwards of 1.25% and that too from secured instruments.
This also explains the cause for the spurt in demand for rupee or the excess supply in dollars, said a fund manager.
The rupee on Thursday opened firmer from the previous day's close of Rs 61.76 to the dollar at Rs 61.53 and ended at Rs 61.12.
Market participants expect the rupee to gain strength in the near term. Most said the trend would continue as long as the rate differential remain conducive for FII participation.