Indian Stock Market: What Are FPIs Up To?  

In recent weeks, the Indian stock market has been struggling to sustain any upside. What is evident from the current downtrend is that domestic investors either don't want to, or are unable to completely absorb the selling pressure from the foreign portfolio investors (FPIs).

With this, the narrative that Indian market is decoupled from world markets and not subject to FPI vagaries falls flat. As also the view that domestic investors would always come to the rescue of the market is being challenged.

But the sale by FPIs over the last six months seems different. There is a sense that the Indian stock market is being isolated in the way it has received below-par foreign flows over the period, compared to other emerging and developed market peers. Even more worrying is that India-dedicated foreign funds have sold more than even passive investors like exchange-traded funds (ETFs) and index funds.

The role played by FPIs in the Indian markets cannot be over emphasised. Any sustained rally in the stock market is unthinkable without the participation of FPIs.

Currently, the FPIs hold Indian equities to the tune of 16 per cent of total market capitalisation, which is at a 10-year low (it was 20.4 per cent in February 2015). As of end-February 2025, the equity of the FPIs' Assets Under Custody (AUC) stood at Rs 62.4 trillion, 8 per cent lower than Rs 67.8 trillion in January 25, and Rs 78 trillion in September 2024.

Why The Exodus? 

The 50-share Nifty is down 16 per cent from its high achieved in September last year, and foreign outflows stand at a massive Rs 3 trillion since then. The indices for small and mid-capitalisation companies have corrected even more. Nifty recorded five consecutive months of selling in February, for the first time in the last three decades. Such was India’s bull run that benchmark indices have not seen an over 5 per cent correction in any month in the last three years. 

“Directionally, India has tracked EMs for more than two decades, but has seen a big disconnect in the last two years,” said Nuvama Institutional Equities, in a strategy report on March 10.

“We think the correction is owing to India’s earnings reconciling with not just weak top-line growth (as reported in recent quarters), but also its emerging market (EM) peers. High valuation only added to the misery. This spurred FII outflows undermining (strong) India’s balance of payment and macro liquidity.”

The Reserve Bank of India’s (RBI's) recent repo rate cut by 25 basis points in February also reduced the interest rate differential between India and the US. This, and subsequent Rupee depreciation, further incentivised capital outflows. But, broadly, market players attribute FPI outflow from global equities and India to the following few reasons:

Dump Equity, Buy Debt: The consensus is that global interest rates have peaked. To lock in higher yields, global institutional investors have started to allocate more to debt as compared to global equities in recent months. With higher perceived risk towards global equities, debt has rallied even more. 

Dump EM, Buy DM: In the last few months a lot of money has flowed to equities in the developed market, especially the US and Europe, at the cost of emerging markets like India. With Donald Trump and imposition of tariffs, US is considered safer in a volatile global order. 

Dump India, Buy China: With assets cheaper after years of underperformance, announcement of some low impact reforms by China, has prompted a shift of money from India to China in recent months. 

When Will Heads Turn?

After the recent correction, there seems to be some comfort on the valuation front. According to Nuvama, Nifty is now trading at a 50 per cent valuation premium to EMs — close to its long-term average of 45 per cent (it was 70 per cent last September). Even on absolute basis, Nifty valuations now look more reasonable with one year forward P/E (consensus) currently at 18.1 times earnings, below its 5-year average of 19.4 times earnings.

But what about fundamentals? Analysts have been downward revising their corporate earnings estimates for fiscal year 2025 and 2026 in recent months, indicating their poor outlook on overall growth in the near term. To point out, it is this corporate growth that market chases driving stocks higher in turn.     

However, for the long term, there are analysts that are sticking their neck out and betting on India. “We remain ahead of the consensus on earnings. Crucially, India's relative earnings growth is turning up based even on the more conservative consensus forecasts. In the meanwhile, valuations are the most attractive since the Covid pandemic. The market has ignored the RBI's policy pivot, and a strong budget from the government, among other positive developments since early February. India's low beta characteristic makes it an ideal market for the uncertain macro environment that equities are dealing with. Importantly, our sentiment indicator is in strong buy territory,” said Morgan Stanley said in a research report on March 10.  

In conclusion, although a lot of FPI selling in recent months is due to high valuations of Indian market, it remains to be seen when and how any economic growth recovery will start factoring in the price. Although the US tariff — related uncertainty and fear of global trade war remains, it looks like India could track global equities from hereon, before standing out basis its good long-term fundamentals. 

(The writer is a Mumbai-based analyst and researcher. Views are personal)