TOKYO -- Japanese retail investors have lost confidence in Indian equities, with high oil prices and a weak rupee sinking inflows into India-focused stock funds to a five-year low.
Assets under management have decreased at 14 of Japan's 15 largest Indian stock funds this year.
Experts say domestic political uncertainty leading up to India's general elections due by May 2019 have also contributed to a sharp drop in foreign portfolio investment.
Toru Nishihama, chief economist at Dai-ichi Life Research Institute, pointed to India's vulnerable fundamentals. "The country's double deficits remain a chronic issue," Nishihama said, referring to India's current-account and budget deficits. He predicts slower growth for Indian GDP in 2019.
Net inflows for the sector have plunged by more than 90% from a year earlier, totaling 55 billion yen ($486 million) as of October compared with 814 billion yen for all of last year. The tally as of October is the lowest since an outflow of 113 billion yen in 2013.
The funds have experienced net outflows for five consecutive months through October, data from fund tracker Mitsubishi Asset Brains shows. If the trend continues in November and December, it could result in a net outflow for all of 2018.
The selloff began in June -- the first monthly outflow in over two years -- and reached 17 billion yen in October.
Surging oil prices prompted investors to cut their exposure to India, which imports 80% of its crude. A depreciating Indian currency sent shares sliding in September and October, with the benchmark Sensex index declining 10% in the two months. Defaults by Infrastructure Leasing & Financial Services, a major issuer in the country's corporate debt market, also sparked a sell-off in the financial sector.
Indian stock funds in Japan had enjoyed a boom in 2017.
India's economy grew even as Prime Minister Narendra Modi introduced reforms such as the launch of the Goods and Services Tax. Manufacturing and consumer spending drove gross domestic product to $2.5 trillion last year, according to the World Bank, as India overtook France to become the sixth-biggest economy.
The country's growth potential drew investors to mutual funds focused on Indian stocks. Nomura Asset Management and some other investment firms stopped taking investors for the funds at one point after exceeding the targeted amount.
But investors turned wary this year. Indian shares dropped sharply this summer amid escalating trade tensions between Washington and Beijing as well as uncertainty surrounding Turkey's financial crisis and diplomatic row with the U.S.
Assets across Asia were dumped, and concerns about China's economic slowdown also worsened investor sentiment.
The U.S. Federal Reserve's push toward rate hikes caused anxiety as well. Some analysts predict the Fed will raise interest rates two to three times in 2019. Higher U.S. rates tend to make assets in emerging economies less attractive, thus prompting Indian shares to plummet.
Chiho Shimada, chief editor at research firm Ibbotson Associates Japan, adds that "investors are gradually moving their capital out of emerging economies."
Nomura Asset Management operates the largest India equity fund in Japan, with assets under management topping 400 billion yen as of the end of October. But those assets have decreased 30% since last year with outflow of 63 billion yen. Assets peaked in January at nearly 600 billion yen.
"India's Sensex hit an all-time high in August, which led investors to take profit," said Masakazu Kitazono, chief product manager at Nomura.
Though Kitazono remains positive about India's economic outlook and growth, he added that "as a result of the currency effect, yen-based investors became worried about how Indian stocks dropped significantly in a short amount of time."
One Japanese retail investor who joined the Indian equity fund frenzy last year said he withdrew his capital.
"I still believe India's economy will continue to grow, but with so much uncertainty surrounding global markets and the U.S. rate hike, I thought it better to sell," the investor said.
Eastspring Investments and Daiwa Asset Management also have seen outflows this year. Sumitomo Mitsui Asset Management, which operates the second-largest India stock fund in Japan, has maintained an inflow, despite a decline of 60% compared with last year.
Though New Delhi seeks ways to stabilize foreign portfolio inflows, the volatility is unlikely to impact Modi's run for a second term next year, mainly due to the absence of a strong challenger. Indian elections also still tend to revolve less around the economy and financial markets in favor of religion, caste and language.
External factors could deepen foreign portfolio outflows in the coming months, an October report by Care Ratings finds.
"The domestic macroeconomic concerns such as weakness in currency, risks of inflation [and the] trade deficit would also weigh in on inflows," the report said. "As a best-case scenario we could expect overall net flows to turn marginally positive in case external conditions improve in the next few months."
Nikkei staff writer Kiran Sharma in New Delhi contributed to this story.