Foreigners Short India Stocks Heavily, $3.5B Pulled Amid Polls

Key Takeaway

• Foreign investors are the most short on Indian stocks since 2012, with net short positions in index futures at 213,224 amid election jitters.
• May saw a withdrawal of approximately $3.5 billion from Indian equities, influenced by election uncertainties and the allure of cheaper Chinese stocks.
• Election outcomes could significantly impact the Sensex and Nifty indices, with potential scenarios ranging from notable declines to record highs.

Election Speculation and Market Impact

Foreign investors have shown a marked increase in pessimism towards Indian stocks, the most significant in over a decade, amid the ongoing national elections. This sentiment is largely driven by speculation that Prime Minister Narendra Modi's Bharatiya Janata Party (BJP) may secure fewer seats than previously anticipated. The data compiled by Bloomberg reveals a surge in net short positions in index futures contracts to 213,224, indicating a strong bearish outlook in the derivatives market. This trend coincides with foreign investors withdrawing approximately $4 billion from Indian stocks since the beginning of April. The speculation stems from a noticeable dip in voter turnout in recent phases of the election, raising concerns about the BJP's performance and its implications for Modi's policy reform agenda.

Market Reactions and Foreign Outflows

The cautious stance of foreign investors is further evidenced by the significant outflows from Indian equities, marking the largest monthly withdrawal since June 2023. Approximately $3.5 billion has been pulled from India's stock markets in May alone, driven by election uncertainties and the high valuations of Indian equities. This shift has been compounded by the appeal of cheaper Chinese stocks, prompting some funds to reallocate investments. The MSCI China Index has recently outperformed the MSCI India Index in year-to-date performance, despite trading at nearly half the valuation on a 12-month forward earnings estimate basis. Notably, high-profile investors have shown increased interest in Chinese technology stocks, indicating a broader market rotation.

Election Outcomes and Market Prospects

Analysts have outlined potential scenarios following the election results, each with distinct implications for the Indian stock market. A significant loss for Modi's BJP could lead to a notable decline in the Sensex and Nifty indices, while a comfortable majority could stabilize and potentially boost the market. Achieving near the 400-seat mark could propel the indices to new records. These scenarios underscore the market's sensitivity to political developments and the larger downside risk amid recent volatility and foreign selling. Despite the current outflows, the upcoming MSCI Inc. review is expected to bring about $2 billion in passive inflows to India, offering some support to the market.

Street Views

• Frank Benzimra and Rajat Agarwal, Societe Generale SA (Bearish on Indian stocks):

  "What is not priced in is disruption, which could lead to a sharp and swift correction in the Nifty Index, similar to what we saw in 2004."