NIFTY All Time High: Who is Responsible?

The Nifty and Sensex have reached their highest levels of over 19,000 points and 66,000 points, respectively, and the market is growing very quickly.

After the Indian stock market experienced a decline during the COVID-19 pandemic, it began to recover. During this recovery phase, several "Stock Market Experts" claimed that the Indian stock market is primarily influenced by Domestic Institutional Investors (DIIs) and retail investors. This assertion is based on factors such as the growing popularity of SIPs (Systematic Investment Plans) and the increased participation of individual retail investors in the market. They said things have changed, and now our stock market doesn't depend much on Foreign Institutional Investors (FIIs).

But is this really true?

Let's look at the recent market rally to understand how much influence FIIs have in the Indian market.

During the current rally, which started in March 2023, something important happened.

On March 22, 2023, the Federal Reserve, which is the central bank of the United States, increased interest rates by 0.25%. This made the benchmark interest rate increase from 4.75% to 5%. The interest rate was increased to control inflation in the United States.

Now how did an interest hike in the US trigger the bull rally in Indian markets?

Let’s look at all the pieces in this puzzle to better understand the relationship between…

Inflation, Interest Rates, and Stock Markets

When inflation is very high, it's the regulators' job to slow it down. They have different tools to do this, and one of them is adjusting interest rates.

When inflation is going up, regulators raise interest rates. This has both advantages and disadvantages. The advantage is that higher interest rates make it more attractive for banks and other institutions to invest in government securities because they offer higher risk-free returns. When banks invest their money in government bonds, they have less money to lend to people and businesses. This reduces the amount of money in the economy, which reduces inflation. The disadvantage is that this reduced supply of money in the economy can slow down the economy.

But how does this relate to the stock market?

Now, let’s think.

As retail investors, we often prioritise higher returns and are willing to take on more risk. However, big institutions and banks have a different approach. For them, managing risk is more important than maximising returns.

Now, consider this: If the United States, which has the strongest economy in the world, offers a risk-free interest rate of 4.5-5%, wouldn't it make logical sense for these institutions to withdraw their money from the stock market of a developing nation (like India) and invest it in US government securities with zero risk?

This shift in investment can lead to a fall in the stock market of the developing country in question.

So, it is clear that when inflation is high, central banks increase interest rates, resulting in the redirection of funds from the stock market, leading to a fall in the stock market. Conversely, when inflation is low, interest rates are lowered, which can contribute to the rise of the stock market.

Now that we have understood the relationship between inflation, interest rates, and the stock market, let's look into what is happening in the Indian stock market.

Let's continue from where we left off…

US Fed's March 22nd Interest Rate Hike

The Federal Reserve's goal is to bring down the inflation rate in the United States back to 2%.

Looking at the latest inflation data,

We can see that inflation in the United States decreased to 2.97% in June 2023. It is now unlikely that the interest rate will be raised further, even though Powell, the chairman of the Federal Reserve, mentioned the possibility of future rate increases if necessary.

Since the current monetary policy seems sufficient to curb inflation, another interest rate hike is unlikely. Thus, it seems that the interest rate has reached its peak, and we can expect interest rates to decrease in the near future.

As a result, after the news on March 22nd, there has been an increase in cash inflow from FIIs (Foreign Institutional Investors) into the Indian market.

Now, let's examine the cash flow in the Indian stock market before the Federal Reserve meeting.

Starting from the beginning of 2023, FIIs withdrew a total of ₹50,557 crores, while DIIs made purchases worth ₹83,199 crores. The net cash inflow was approximately ₹33,000 crores.

During this period…

Nifty experienced a decline. And this can be attributed to the selling pressure exerted by FIIs.

Now, let's analyse the data after the Federal Reserve meeting, starting in April.

Indian market witnessed a cash inflow of ₹75,400 crores from FIIs, while an outflow of ₹4,762 crores from DIIs. The net cash inflow amounted to around ₹70,000 crores due to the aggressive entry of FIIs into the Indian market.

Why did this happen?

It is because the Federal Reserve's interest rate hike was likely the last one.

As a result of these factors…

a strong bull rally has commenced in the market. Both the Nifty and Sensex are reaching new all-time highs, indicating a significant upward trend in the stock market.

Looking ahead, if the US inflation data shows a decline, there is a possibility of more FIIs entering the Indian market, resulting in stronger buying activities.

The Bottom Line

In conclusion, the Indian stock market has witnessed remarkable growth, reaching all-time highs in the Nifty and Sensex indices. While DIIs and retail investors play a significant role, the influence of FIIs cannot be disregarded.

The Federal Reserve's latest and possibly last interest rate increase in March 2023 sparked a bull rally as institutions and banks shifted their investments to emerging markets. With declining US inflation and unlikely future rate hikes, FIIs have aggressively entered the Indian market, resulting in a substantial cash inflow. Looking ahead, if US inflation continues to decrease, the possibility of more FIIs entering the Indian market indicates a promising outlook for sustained growth and a robust bull rally.