Domestic financial conditions improve with lower FPI outflows

• Domestic financial markets have been facing pressure from foreign portfolio investor (FPI) outflows since October. However, the selling intensity reduced in November, which improved domestic financial conditions.
• CRISIL Financial Conditions Index (FCI), which is a combination of parameters from India’s major financial market segments,1 rose to 0.3 in November from -0.2 previous month, implying easing financial conditions. However, the FCI in October-November averaged 0.1, lower (tighter) than 0.7 in the second quarter.
• Lower FPI outflows on month supported the improvement in the FCI.
• That said, FPIs remained net sellers for the second consecutive month. Stronger US dollar and Treasury yields after the presidential election results there have been exerting pressure on FPI flows.
• With FPI outflows and a strengthening dollar, the rupee hit a record low in November. However, the Reserve Bank of India’s (RBI) interventions in the forex market could have limited the rupee’s depreciation.
• FPI outflows and increased currency demand during the festival season have also been draining the domestic liquidity. The RBI expects it to remain under pressure in the near future, which prompted the central bank to cut banks’ cash reserve ratio (CRR) 50 basis points (bps) in December.
• In our view, conditions are turning favourable for a rate cut in February. Inflation is showing signs of softening while the impact of the RBI’s past rate hikes has been squeezing credit growth this fiscal.