FII flows may not always lead to higher Sensex and vice versa By RIDHAM DESAI, MORGAN STANLEY We have pointed out earlier how the correlation of returns between Indian equity indices and a host of other markets is rising and close to highs. We concluded that global factors are driving the market much more than idiosyncratic India factors. We see the same story when we measure the beta of the Sensex to FII flows. This beta is an estimate of how the Sensex moves relative to the change in FII flows with both variables measured as absolute weekly change. Market participants believe that FII flows are important to the market. However, the correlation between short-term returns and FII flows is weak. The correlation happens to be strong only for longer-term returns, i.e., 12-month returns to be more specific. Indeed, these correlations also vary over time. Thus, FII flows have changeable efficacy on market moves. Therefore, market participants should not assume that FII flows will lead to a higher Sensex and vice versa. The rising beta of the Sensex moves to FII flows is being primarily driven by high correlation between the two rather than relative volatility. That correlations are just off highs only underpins the fundamentals of the Indian market and the economy which is the capital market-led funding of India’s high external deficit. The beta of the Sensex to FII flows has been notably higher than history since the financial crisis. While the economy and the markets got a substantial lift from global factors between 2003 and 2007, the beta of the market to flows was not as high as we have seen since 2008. The credit crisis and the ensuing policy lethargy explains the rising beta of Sensex moves to FII flows. Another observation is that the absolute volatility of both Sensex returns and FII flows is low. Volatility tends to be mean reverting, so if anything, it tells us that volatility could rise in the coming months. Again, the source of such a rise is likely to be global rather than local.