FII Inflows in India vs QE-II – Is there any relation?

Very often, we say that the FII inflows in India lead to domestic indices’ upward movement. To a large extent, it is true. Post the economic bleak in 2008, the advanced nations cut their interest rates to spur the economy which has almost dried. Developed nations like US announced a series of quantitative easing and credit easing programs in a bid to aid faster recovery and fight deflation. It is widely believed in academia that QE-I and QE-II leads to increasing capital flows into the emerging market economies (EMEs). This also holds true for India as we largely believed that QE-II led to large FIIs inflows in India.

However, Anand Shankar, Reserve Bank of India (RBI) in his paper “QE-II and FII inflows into India – Is there a Connection?” says that FII inflows have fallen after the November 03, 2010 announcement of QE-II by Fed which is very contradictory to popular belief of increased inflows.

The first phase of longer term asset purchase in the US was terminated on Mar 31, 2010, with about $1.75 trillion worth of asset purchase by the Fed between Nov 2008 and Mar 2010.  However, this injection seemed insufficient to aid faster recovery and fight deflation and control unemployment rate. On Nov 03, 2010, the US’s Fed announced another series of quantitative easing, widely known as QE-II worth $ 600 billion over an eight month period along with reinvestment of principal payments from agency debt and mortgage backed securities to the tune of $ 250 billion - $ 300 billion.

Anand Shankar further says,

“One would have expected the FII inflows to increase significantly after November 3, 2010 announcement of additional purchase of treasury securities. However, results suggest that FII flows have indeed fallen in the period after November 3, 2010. One explanation is that since the markets had already anticipated and factored in the effect of QE in their behavior, they were not surprised by the announcement of QE-II on November 3, 2010.”

The paper says that there have been other factors which led to movement of FII inflows in India in that period. The paper results suggest,

“Post the announcement of QE-2, FII inflows have fallen significantly. The fall in FII inflows post November 3, 2010 has been explained via factors negatively affecting stock market returns in India using global and domestic factors which include sovereign debt problems in the Euro-area, political tensions between North and South Korea and in the MENA region, high inflation in India and policy rate hikes by Reserve Bank of India.”

This finding has been explained using expectation factoring behavior of market participants and developments in India and abroad.

A nice analysis by Anand Shankar; thanks to RBI.