Foreign Institutional Investors (FIIs) have been steadily withdrawing from the Indian stock market, with a notable outflow of ₹60,859 crore (approximately US$7 billion) as of January 22, 2025. This massive exodus has sparked concern among Indian market analysts and investors, suggesting a potential shift in investor sentiment towards the Indian economy. Key factors contributing to this trend include lofty stock valuations, a depreciating rupee, and sluggish corporate earnings growth.
The lofty valuations of Indian stocks have been a primary driver of the recent selling frenzy. Despite Indian equities' impressive performance over the past couple of years, downgrades in earnings expectations have fueled skepticism about the sustainability of these high valuations. Notably, Indian corporate earnings growth, which had expanded at a double-digit pace for four consecutive years, has decelerated over the last couple of quarters.
As a result, total earnings growth for FY25 is now expected to be a single-digit percentage, a significant departure from initial estimates of robust growth. This downward revision has prompted Foreign Institutional Investors (FIIs) to reassess their investments, leading to a substantial sell-off.
The sharp devaluation of the Indian rupee against the US dollar has been another significant driver of FII outflows. Over the past two years, the rupee has plummeted from ₹73 to ₹86 per dollar. This depreciation erodes the dollar value of foreign investors' returns when repatriated, thereby reducing their profit from Indian equities.
To illustrate, consider an FII selling ₹84 crore worth of equities when the dollar exchange rate was ₹84. The investor would receive approximately $10 million. However, if the returns were converted at the current exchange rate of ₹86.4, the value would drop to around $9.72 million, representing a decline of nearly 2.8% solely due to currency fluctuations.
The global investment market has witnessed a major shift, with Foreign Institutional Investors (FIIs) increasingly favoring the US markets. Amidst rising interest rates in developed economies, stable returns are becoming more appealing, particularly when compared to emerging market equities, such as those in India. As central banks continue to hike interest rates to combat inflation, investors are seeking safe-haven assets in developed markets. Reflecting this trend, HSBC recently downgraded its equity rating for Indian equities from "overweight" to "neutral," citing growing concerns about inadequate profit growth and overvaluation in the Indian market.
India's slowing economic growth has further complicated matters. The latest GDP growth forecast for FY25 stands at 5.4%, underscoring dwindling expectations. Against this economic backdrop, foreign investors have become increasingly cautious about the investment risk in India, which appears to be heading into a decline. As a result, investor sentiment has shifted, with many adopting a more conservative approach when assessing the long-term sustainability of investments in India.
There are several other global economic factors that also influence FII behavior. Notably, the looming threat of recession in the US and other advanced economies is prompting investors to reassess their risk exposure. In anticipation of a global economic downturn, investors are likely to liquidate their positions in higher-risk assets, such as emerging market stocks, and seek safer havens. This flight to safety could exacerbate capital outflows from India. Furthermore, the anticipated reopening of China's economy following its COVID-19 lockdown could divert investment flows away from India, providing an alternative destination for funds.
The convergence of high stock valuations, currency depreciation, disappointing corporate earnings growth, and shifting global investment trends has led to a persistent sell-off of Indian stocks by Foreign Institutional Investors (FIIs). As a result, Indian markets are likely to face a challenging period ahead, as FIIs rebalance their portfolios towards more stable markets, such as the US, and reassess their risk exposure amidst economic uncertainty.
Ultimately, the future trajectory of Indian markets will depend on the interplay between global market dynamics, domestic economic conditions, and the restoration of investor confidence.