Foreign investors have valid reasons to exit. The India Story needs to regain its charm

A recent sovereign rating upgrade by S&P seems like a grudging acknowledgement of a tautology by the rating agency, rather than a big achievement.

Yet, global investors don’t seem to be impressed. Foreign portfolio investor (FPI) flows into equities stand at a negative $13 billion in 2025 so far. In the last five years, twice (in 2022-23 and 2024-25) have FPI outflows been at all-time-high levels. There is both a rationale and an opportunistic trigger for this.

The opportunistic trigger is very clear. Of all emerging market (EM) assets, one of the most liquid—indeed, perhaps the most liquid—are listed Indian equities. Thanks to burgeoning retail flows into stocks, both directly and via mutual funds (MFs), India’s capital markets are among the busiest in the world.

The wall of liquidity engendered by Indian retail investors lets FPIs (and to be fair, even Indian promoters) exit profitable-but-richly-valued Indian positions and rotate funds into other avenues with better price-value equations.

The rationale is clear too. Indian listed equities trade at price-earning multiples that are among the highest in the world, at par with US equities (with the Nifty index trading at about 20-21 times annual earnings). Over the last five-six quarters, earnings growth has stopped supporting such valuations. During this period, broader market earnings have averaged only single digits.

In comparison, US markets have continued delivering mid- to high-teens earnings growth in dollar terms. Further, China, delivering near-US type earnings growth, has stocks trading at just 12-13 times earnings. For a long while, India’s valuation premium over EMs in general and China in particular have been justified by better capital efficiency, more stable growth and higher corporate earnings growth.

In the last few years though, others (including China) have started catching up on capital efficiency markers. Which leaves India’s relative attractiveness down to a single variable—growth. As earnings growth flags, foreigners take their money out.

India at a crossroads: Structurally, India faces tough questions on its growth profile.

One, IT outsourcing, the single-biggest driver of growth for the last three decades, is under increasing threat. From being the largest provider of high-paying jobs, this sector is now shedding jobs in order to deal with the AI threat.

In the past, some 300,000-400,000 graduates hired by the IT industry every year would fuel a consumption boom. As AI structurally reduces the sector’s demand for a medium-skilled workforce, millions of India’s educated might now be hard pressed to find alternative avenues of well-paid employment.

Two, India lags other countries in the AI race. At least for now. Large language model (LLM) initiatives are still in their infancy, not mature enough to raise the sort of capital being invested in the US and China. India is also just about starting off in its drive to manufacture semiconductors at home.

Three, conservative government finances have been matched by equally conservative private corporate investment. Consequently, fixed capital formation, the single biggest driver of economic growth, has remained anaemic at an aggregate level for around a decade now. To break this deadlock, something has to give. But as of now, there don’t seem to be too many ideas on the table.

A new geo-economic challenge that would make Hobson proud: While US President Donald Trump’s second term in power has kept the world at large on edge, the ease with which the wheels have come off India-US relations this year suggests that “hesitations of history" were based on India’s general lack of all-round leverage.

Today, our geo-economic dilemmas are coming to a head. Even if India’s Russian oil trade was the real reason for the extra 25% tariff imposed by the US, switching import sources would be a tough swap.

The discount on Russian oil, averaging $10-12 per barrel, results in annual savings of about $6 billion. More than half of it accrues to public-sector refiners, a windfall that partly helps finance an energy subsidy (primarily on cooking gas) that is not always financed fully by the Union budget. Further, a portion of our Russian oil purchases—placed at $40-50 billion annually—is settled in rupees, reducing friction costs and creating a buffer for our external account.

Most importantly, if India boycotts Russian oil, it could send global crude prices higher. This would put the world at risk of stagflation, which is hardly a better option than a global slowdown.

Our Russian oil trade, however, is very likely a red herring. America’s real rationale for the extra 25% tariff very likely differs from the stated reasons and offers India little comfort over prospects of a quick resolution. Access to India’s agricultural market seems like the top ask of American trade negotiators, but this is also the reddest of all trade red lines for the Indian political establishment.

Acceptance of any US mediation in an India-Pakistan conflict, which appears to be another big ask by the US, is an equally deep-set political red line for New Delhi.

We need new ideas as old ones have run their course: FPIs seem to be exercising a cyclical pause that coincides with India’s need for new ideas. This cycle will play itself out and an equity market upswing will surely occur at some point. But India must find a new path for the future.

If mistakes are made, they should be new ones, instead of trying the same things and making the same old mistakes. Foreign investors are merely canaries in this mine.

These are the author’s personal views.

The author is the chief investment officer of ASK Private Wealth.