Let some capital flow out, so more can flow in: Why this matters

One of the most striking shifts in India’s capital market ecosystem in recent years has been the rise of the Indian household as the country’s largest provider of risk capital. This is a structural transformation that is reshaping the engines of capital formation and influencing incentives for both issuers and global investors. 

 

While a welcome trend, it carries implications that merit informed policy debate.

 

As the Securities and Exchange Board of India (Sebi) has highlighted, retail participation in securities markets has seen more than a threefold increase over the past five years, to over 136 million unique investors now. Reflecting this trend, net domestic demand for listed equities across primary and secondary markets, through mutual funds, pension funds, insurance companies, and direct retail participation reached a record ₹8.8 trillion in the 2024-25 financial year (FY25), or an equivalent of $100 billion, more than double the previous record.

 

Consequently, net demand across primary and secondary equity markets reached a record ₹7.5 trillion, despite ₹1.3 trillion of net foreign portfolio investment (FPI) outflows that year. The Indian saver has clearly sustained domestic equity demand in recent times.

 

On the supply side, equity offerings across initial public offerings (IPOs), follow-on public offerings (FPOs), qualified institutional placements (QIPs), rights issues, and offer-for-sale also saw a record ₹4.6 trillion in FY25, around 40 per cent higher than the previous record. Record demand for risk meeting record supply of equity issuance augurs well for capital formation. This trend continues into the current fiscal year.

 

Yet, the excess of demand over fresh supply has steadily widened over the past five years, reaching ₹2.4 trillion in FY24 and a record ₹2.9 trillion in FY25. This excess demand has been met by secondary market selling by owners and strategic investors. Given this demand context, it is unsurprising that our benchmark indices have grown at 14 per cent compound annual growth rate (CAGR) since March 2021, outperforming most global markets, even as foreign portfolio flows have remained muted.

 

Beyond public markets, the rise of the domestic investor extends into private markets as well. Commitments to alternative investment funds (AIFs), which channel capital largely into unlisted equity and credit, have risen from ₹4.5 trillion in March 2021 to ₹15.1 trillion in September 2025, at a 31 per cent CAGR. Over the last year, commitments to AIFs have risen by ₹2.7 trillion, or the equivalent of $30 billion. Anecdotally, direct domestic participation in unlisted investments is growing, too.

 

In parallel, net foreign direct investment (FDI), once a major net financer of India’s private markets, declined from ₹3.25 trillion in FY21 to just ₹0.07 trillion in FY25. This partly reflects rising outflows as strategic investments and foreign ownership are monetised in buoyant public markets. In addition, with rising domestic risk appetite, foreign investors may be finding fewer attractive entry points in both listed and unlisted space.

 

While the pool of domestic risk savings is growing, its deployment is relatively narrow. Domestic equity has become the dominant destination for such savings, partly because alternative asset classes remain limited or tax-inefficient at scale. Outside provident funds and insurance, retail participation in fixed income remains modest, as does its engagement with real estate investment trusts (Reits), infrastructure investment trusts (Invits), securitised assets, and commodities.

 

International diversification is also limited for most households, outside of gold. The Liberalised Remittance Scheme (LRS) exists but remains operationally complex for smaller investors. Meanwhile, the overseas investment limit for Indian mutual funds has remained capped at $7 billion since 2008. On the surface, these constraints may appear reasonable from a macro-prudential and foreign-exchange management standpoint. Yet, just as high import barriers can reduce export competitiveness, persistent barriers on outward investment can unintentionally reduce competitiveness of domestic capital markets and, therefore, weaken net foreign investment inflows. Any such loss of competitiveness could also leave us with a market ecosystem where high domestic valuations are achievable even with modest risk-taking, reducing the incentives for companies to invest, innovate, or undertake productivity-enhancing initiatives.

 

None of this diminishes the significance of what has been achieved. The rise of the household investor is a milestone in India’s financial democracy. But neither durable investor prosperity nor sustained capital formation can be built on domestic equity-centric savings alone. A mature investment ecosystem needs three avenues: Domestic equity; other domestic asset classes such as fixed income, real estate, commodities and alternatives; and, finally, some access to global markets.

 

India has made the first leg very efficient; the next phase should be to gradually strengthen the second and third.

 

Two policy priorities follow

 

First, we should consider allowing greater external diversification through India, not away from India. A calibrated and gradual increase in overseas exposure through Indian mutual funds, appropriately sequenced given macro-stability considerations, would enable households to diversify globally while ensuring that redemptions return to India. This approach should enhance risk-adjusted returns for households, ease any perceived valuation pressures in domestic capital markets, strengthen market incentives for risk-taking and fresh investment, and create more room for fresh FPI and FDI flows.

 

Given India’s strong growth prospects, such an opening may well result in higher net capital inflows over time and support our external balance. At worst, it could temporarily shift a small part of the Reserve Bank of India’s foreign exchange reserves into household portfolios.

 

Second, we should deepen investible domestic asset classes beyond equity, and scale retail-friendly access to fixed-income markets, hybrid instruments, REITs and InvITs, securitised pools, municipal bonds, and commodities. 

 

The goal is not to draw households away from equity, but to enable prudent risk-based asset allocation that is not dictated unduly by tax considerations. This would strengthen balanced and sustained long-term capital formation and wealth creation.

 

India’s markets today are powered by the rising confidence of Indian households. This confidence should be preserved and strengthened with wider avenues for asset diversification, including to global markets. Doing so will offer investors better risk-adjusted outcomes, keep domestic markets efficient and competitive, allow for larger net foreign investment inflows, and ensure market signals that encourage sustained investment and capital formation.

 

The author is a former whole-time member, Sebi. The views are personal