Foreign hand rocks the stock markets

MUMBAI: So what ails the stock market? Some of the current bearishness is due to factors like rising domestic interest rates, expectations of a slowdown in India Inc’ earnings and government actions that lead one to believe that it wants to control prices.

While one may also blame the not so exciting budget, the fact is that even before the budget speech started, the markets were down. Among the bigger reasons for the fall is the outflow of foreign funds from India due to fears about the unwinding of yen-carry trades. And, interestingly, the intentions of foreign institutional investors (FIIs) were visible from day 1 of the new derivatives settlement, beginning February 23.

The FIIs open interest (based on number of derivatives contracts) in index futures (most of it being Nifty) has been on a rise (adjusted for change in contract size) since  February 23, a day after February month contracts were settled (February 22 was the last day for F&O settlement). As on March 14, the rise in open interest in index future (FII) has been 49% over February 22.

In the stock futures segment, too, FII open interest jumped 30.3% to 592,652 contracts on February 23; so is the case with index options, which jumped 111.71% to 246,730 contracts. Though some of it could be due to the change in contract size. However, in these cases, the FIIs have been net buyers to a smaller extent.

Interestingly, the FII were net buyers in the cash segment to the tune of Rs 4,287 crore on February 23, the day since short positions started building up in index futures, which is visible from a further break-up of data. The FIIs have been net sellers in index futures between February 23 and March 5 totalling Rs 3,861 crore; between February 26 and March 5, they also sold equity (cash segment) worth Rs 3,068.60 crore. And all through these days, their open interest in index futures kept rising. Also, the Japanese yen appreciated by 5% against the US dollar between February 22 and March 5; it is up 3.4% up to March 13. On March 6, open interest fell 5% to 740,643 contracts, the day they were net buyers in index futures (Rs 1,338 crore). The next two days too saw some buying in index future - i.e. some reversal of short positions took place.

That FIIs dominate the Indian markets can also be gauged from the trend in discount/premium for Nifty futures vis-à-vis the S&P CNX Nifty, which has shown correlation to the movement in FII open interest in index futures.

India, though, is not alone to face the brunt of FII behaviour as the impact is visible across global markets. A Morgan Stanley report (dated March 8) said, “Emerging market equity funds had net outflows of $8.9 billion in the week ended March, 2007, with Asian funds accounting for nearly 50% of aggregate redemptions.” India’s share of weekly outflows from Asia Country funds was pegged at $740.9 million by a Citigroup report (dated March 9).

The Citigroup report said, “The “yen carry trade” concern not only affected Asia but also the rest of the emerging markets with $4.8 billion redeemed from Latin America, EMEA (Europe, Middle East) and global emerging market funds. These, together with $1.7 billion in outflows from international equity funds, suggest that $10.6 billion was withdrawn in one week.” It further said, “Asian markets are likely to see more downside than upside risk in the near future - in May/June last year, $4.9 billion in redemptions from Asian funds took place in six weeks. This time, $4.1 billion was withdrawn in just five days. However, the average weekly outflow for the past eight weeks has still not reached the level we saw last year.

Asian markets corrected 20% between May 7 and June 13 last year whereas stocks in Asia have fallen just 6% in the past two weeks.” So, is there more downside left?
To an extent, yes! At least the FII open interest in index future, which continues to be high and, the hefty discount in the Nifty futures to spot price, both indicate that there could be more action in store.