Foreigners are returning to Indian stocks after dumping them in the first half as they look for higher returns amid expectations that major central banks will slow their hiking cycles as price pressures ease.

Fears of an economic recession have lifted hopes that central banks will dial back or even halt the rate hikes to avert a slowdown. U.S. Fed officials indicated in the minutes of their July meeting released last week that they would adopt a less aggressive stance if inflation starts to recede.

According to stock exchange data, foreigners have invested $6.4 billion in Indian equities since the start of July, after dumping over $27 billion-worth over the previous six months.

Domestic investors bought over $30 billion worth of stocks in the first half, helping to prop up the market. But this month, overseas investors have taken the baton, pouring in over $5 billion on hopes that Indian companies will deliver stronger earnings and that a fall in crude oil prices will help narrow the country's current account deficit.

Graphic: Domestic and foreign institutional investments in Indian markets

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Analysts also expect the return of foreign money into Indian equity and bond markets to help the rupee find some reprieve, after slumping over 6.7% against the dollar this year.

Since mid-June, India's major stock index has surged 11.5%, which compares with the MSCI World index's gain of 6%, and MSCI Emerging Market index's decline of 2.8%.

"Foreigners clearly underestimated how India would tackle the pandemic and the economic recovery post-pandemic has been robust in an uncertain global environment," said Neha Pathak,

investment specialist for India Equities at BNP Paribas Asset Management.

"With well-developed and robust equity markets, which have delivered great returns, Indian equities will be hard to ignore for any global investor."

Despite a lacklustre earnings performance in the June quarter, several companies have expressed confidence that a drop in commodity prices will bolster their margins in upcoming quarters.

Top companies like Hindustan Unilever and Tata Motors flagged in recent reports that falling commodity prices from red-hot levels will aid margin improvement in coming quarters.

Aishvarya Dadheech, fund manager at Ambit Asset Management, said Indian equities would be bolstered by a strong earnings momentum and moderating inflation.

"Earnings growth is going to be much better compared to other emerging markets. So, the deep cuts from FII (foreign institutional investors) ownership will reverse from here."

According to Refinitiv data, India's large and mid-cap companies' net profits are expected to grow by 18.9% in 2023, the highest in Asia.

Some overseas fund managers are also diverting money from China, where shares have been hit by an economic slowdown, fresh COVID-19 flare-ups and a crisis in the property sector.

According to a BofA Global Research report, emerging market funds' allocation to India increased to 19.7% in July from 18.1% in June, while the allocation to China dropped to 36.2% from 39.4%.

With China and rest of the world looking at growth challenges, India stands out having better earnings and GDP expectations, said Amit Sachdeva, research analyst at HSBC.

The rupee has also performed better than some of its emerging market counterparts recently. Over the past month, the rupee has dropped just 0.03%, while China's yuan, South Africa's rand and Malaysia's ringgit slumped 1.43%, 0.92%, and 0.74% respectively.

Morgan Stanley expects Asian economies such as India and Indonesia, which are focused on domestic demand, to be more resilient than those dependent on exports, as slowing demand from developed countries affects shipments.

"We continue to be constructive on India, Indonesia, and the Philippines as they are well placed to generate domestic demand alpha," the brokerage said.

DOMESTIC INVESTMENTS DROP

At the same time, domestic investors in India trimmed their positions in August, lured by a rise in bank deposit rates which provide them with risk-free money.

The data showed domestic investors have sold $773 million in Indian equities so far this month.

However, some analysts said slowing domestic investments could just be a blip. According to the BofA report, domestic investments through systematic investment plans (SIPs), in which investors put in money each month, remain robust. Monthly inflows surged to over $1.5 billion in each of the past 10 months.

"Domestic investors may be trimming some (positions). They have been buyers at all levels this year," said Ambit Asset Management's Dadheech.

"Their selling won't adversely impact the market as they won't go gaga in selling."