As is well known, the rally seen last year (and part of this year) between the period of April 2003 and January 2004 was mainly led by robust foreign institutional investor inflows into the country. Relative attractiveness and better growth prospects of emerging markets like India, slowdown in the US and lower returns on US assets led to large inflows of FII money into the country.
The renewed confidence by FIIs led to Sensex reaching an all time high of 6,250.
However, the 'party', as usual was short lived and the FIIs pulled out, seeing the first signs of trouble (in this case, the doubts over the continuation of the reforms process by the new government). But if one were to look at the behaviour of FIIs post the formation of the new government, FII inflows have actually started to rise once more, indicating renewed confidence in the prospects of the Indian economy.
In this backdrop, we asked our viewers whether a hike in the US interest rates would have an adverse impact on FII inflows into the country.
The pie chart, indicates a good majority (54%) of our audience felt that they were confident that FII inflows into the country would be strong. Another 27% were neutral about the issue indicating that they felt FII inflows would be lacklustre or at levels lower than seen last year.
The rest (19%) felt that FII inflows would get adversely affected (possible outflows) due to rising US interest rates.
Focusing our attention first on the segment that feels FII inflows would get adversely affected, we believe that, FII inflows generally chase higher returns as well as relatively risk free assets. In this context, while the US Fed has raised interest rates in the US, the returns on US assets are still not attractive enough for a large scale pull out of FII funds from emerging markets, where the returns are expected to be better.
The US Fed has been measured in its approach to raise interest rates, indicating that the US economic growth has not shown signs of sustaining or is inconsistent at best.
Coming to the majority opinion that FII inflows would be strong, we believe that investors need to view this aspect with some amount of caution. Investors need to realise that FII inflows are relative in nature. That is, FIIs tend to allocate funds among emerging economies (India included) based on the risk return profile of the country.
While India may one of the fastest growing economies among emerging economies, the impediments of achieving a 6.0%-6.5% growth (already revised downward) rate are many. Poor rainfall and a burgeoning deficit, together with rising crude oil prices and expected rise in interest rates may have an adverse impact on the growth of the Indian economy.
Any signs of fatigue (as far as growth in the Indian economy is concerned) would be viewed negatively and there could be a pull out of funds and reallocation to better opportunities in other emerging economies (mainly the Southeast Asian economies).
Investors need to remember that FII flows are volatile in nature and basing ones investment decision based on FII flows may not be a wise idea. As far as the retail investor is concerned, it is virtually impossible to gauge whether, FII inflows are for the long-term or vice versa.
At the same time, retail investors do not need to get overly worried about FII inflows (or outflows) into the country, provided they have a long-term investment horizon.
A long-term horizon tends to negate the adverse effects of volatile FII fund flows. Investors need to realise that a fundamentally strong stock will attract investors (FII or other wise) over the long-term, once the true value of the company is understood.
The idea is to conduct one's own research (or go in for paid research) and hold onto fundamentally strong stocks. Let the fundamentals dictate investment decisions, not FII fund flows.
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.
© 2026