Why are FPIs selling? Zero net inflows persist despite geopolitical risks

India has now gone five years with zero net foreign inflows into the public equity markets, an incredibly long time. This year too, flows are running at a negative $13 billion. Foreign ownership of Indian equities is at a 15-year low. India is now a consensus sell, with regional, global, and emerging market (EM) funds all underweight. In the same five years, domestic flows have exceeded $185 billion. Just as foreign investors have lost interest, domestic investors have never been more bullish.

 

What has caused this lack of interest among foreign capital? Partly, it is due to the general decline in appetite for the EM asset class. EM equities have been a horrendous place to invest, dramatically underperforming both the United States and global equities. A hundred dollars invested in EM equities 15 years ago is today worth $180, compared to almost $500 if it had been invested in global indices. Within this context, India has massively outperformed. Over the past five years, MSCI India delivered dollar returns of almost 15 per cent per annum, compared to just 5 per cent for the broader EM index.

 

Many investors have lost faith in the EM asset class, cut exposure, and India has been a funding source, given its relative outperformance. The original bulls on India, the US endowments and foundations, have been in the midst of a liquidity crunch. Overexposed to private assets, they have an asset/liability mismatch and have been forced to raise capital by selling public equities. Again, India has been an obvious funding source, given its strong absolute and relative performance over the last five years and current high valuations.

 

The Indian economy has noticeably slowed over the past 12–18 months. Growth is clearly a challenge; this is not an economy firing on all cylinders. We seem to be struggling to even reach 6 per cent growth. Understandably, corporate earnings have suffered. At best, earnings per share (EPS) growth will be around 10 per cent this year, similar to FY25. For a market trading at over 20 times forward earnings, earnings disappointments cannot be afforded. You cannot be the second-most expensive market in the world — far above EM valuations — and deliver just 10 per cent EPS growth.

 

Many investors feel that until very recently, there was a sense of complacency, no real plan to accelerate growth. The third term of the government had seemingly got off to a slow start in terms of economic reforms. Unconvinced about the sustainability of the 7–8 per cent long-term growth trajectory and in need of liquidity, many investors booked profits and reduced their Indian equity exposure. You cannot justify India’s valuation premium unless you are fully convinced it will deliver outperformance in both economic growth and earnings. Over the past 24 months, this belief in India’s long-term economic outperformance has come under question, as reforms have lagged. Global investors of all stripes have used the high valuations and domestic investor appetite to cash out.

 

India is also being seen as an artificial intelligence (AI) loser. AI as a theme seems to be entering bubble territory. Since the launch of ChatGPT, AI stocks have accounted for more than 50 per cent of the S&P 500’s returns. Today, eight stocks — all AI plays — represent over 35 per cent of the US market’s capitalisation. Single companies are now spending over $75 billion each on research and capex. We do not have much of a play on large language models (LLMs) or the buildout of AI/data centre infrastructure. Frankly, except for the US and China, no other country is really a player, such is the scale of R&D and capex required.

 

India also faces the question of the future of its IT services industry. Employing over 5 million people, IT services has been a huge driver of white-collar job creation. A few years ago, the industry was hiring 200,000–250,000 fresh graduates annually; this number is already down to less than 50,000. Some fear the industry may actually shrink in terms of manpower over the coming five years as AI reduces the need for software engineers. Was the TCS layoff just the canary in the coal mine? As industry growth slows and employee pyramids bloat, the sector may also need to shed thousands of high-paying mid-management jobs. What will be the macroeconomic impact of this $200 billion export engine slowing to sub-five-per-cent growth? India has scale and low-cost skilled manpower, a real competitive advantage. However, as AI reduces the need for this skilled workforce, will it affect India’s long-term growth trajectory? A fair question.

 

It is important to remember that we have received no FPI flows for five years now. Thus, the current geopolitical stress is not the only reason why investors have turned negative. It may strengthen the bearish case, but is not the primary cause for zero flows.

 

Domestic equity flows appear to be more structural in nature. Even today, after 12 months of zero returns, flows continue to accelerate! When the foreign buyer returns, it could have a disproportionate price impact. We have forgotten how markets react when foreigners and locals buy in competition with each other, it has not happened for five years.

 

With the dollar weakening, down 10 per cent year-to-date, the prospects for non-US equities are improving. This year in dollar terms, global markets have done better. At some stage EM equity as an asset class will get substantial flows. However, for India to get more than its fair share, we have to convince global investors of the sustainability of our 7-8 per cent growth algorithm. With economic growth will come EPS growth. With domestic flows strong, it is unlikely markets will correct significantly in absolute terms. They have already withstood a lot of bad news. Thus, for investors to come back into Indian equities, they will have to probably accept the valuation premiums. The willingness to pay up will come if investors believe we have 20 years of 7 per cent economic growth ahead.

 

This is where the current geopolitical difficulties should be seen as both a wakeup call and an opportunity to press ahead on long-pending reforms across the economy. The list of needed reforms is well known, now is the time to turn adversity into action. We must treat this as an economic crisis and act accordingly to improve our long-term competitiveness and strengthen the building blocks for delivering multi-decadal 7 per cent growth. Initial signs of action are visible, but we have a lot more to do.

 

The last few weeks have also shown us that only economic leverage matters. We frankly have very little. It does not matter that we may be the fourth-largest economy, what is our leverage? We must strive for dominance in certain industries. Absent this, we will never have enough leverage. China’s leverage is not only in rare-earth magnets, it also lies in the fact that it accounts for 35 per cent of global manufacturing value addition, as much as the next 10 countries combined. We cannot aspire for such scale, but if thought through, there are industries of global significance, where we have the opportunity to dominate. We must work on reaching global scale and also become indispensable to certain supply chains.

 

The author is with Amansa Capital