India faces record foreign equity outflows as domestic inflows surge

Foreign investors have pulled record amounts from Indian equities while domestic funds continue to see strong inflows, highlighting a split in market participation. Foreign portfolio investors have sold more than $33 billion worth of direct Indian equities so far this year.

Equity-oriented mutual fund schemes recorded net inflows of Rs 38,306.55 crore in September. This represents a nearly 31% increase from the Rs 29,328.62 crore recorded in August. Net investments rose by Rs 8,977.93 crore month-on-month, signaling a significant acceleration in investor inflows.

Domestic resilience and liquidity dynamics

Despite the record foreign outflows, domestic capital continues to flood the market. Equity mutual funds in India have recorded net inflows every month since March 2021. India's economic growth has also been resilient amid global trade uncertainty and geopolitical shocks.

The underlying fundamentals of the Indian economy remain strong. Finance Minister Nirmala Sitharaman, the country's longest-serving finance minister to hold the office continuously, recently stated the fundamentals remained 'fine'. She attributed part of the market's behavior to liquidity conditions. "Because of the ease of liquidity, ease of availability, people are even exiting easily," Sitharaman said.

Easy availability of liquidity is encouraging investors to exit equity positions more readily. This dynamic, described as excess liquidity, has contributed to the market's underperformance and may continue to do so. Despite the withdrawal of overseas capital, domestic investors continue to provide support.

Index performance and global weighting shifts

India's key benchmark indexes have slipped nearly 12% since January. This decline occurred despite resilient economic growth and strong domestic inflows.

Concurrently, India's standing in global indices has shifted. Its weighting in the MSCI Asia Pacific ex-Japan index has declined to 10% from 19% a few years ago, according to a Goldman Sachs report. This compression reflects changing global investor preferences, with capital shifting toward other markets, particularly those focused on artificial intelligence.

Policy perspective and forward risks

Finance Minister Nirmala Sitharaman addressed the situation in an interview on the sidelines of the International Monetary Fund and World Bank annual meetings in Bangkok. While downplaying concerns about a global AI investment reversal hurting India, she identified a clear forward risk.

Sitharaman said India would not be 'hurt' by spillovers if the global AI investment boom were to reverse, arguing that the country had not received the same scale of AI-related investments as some other markets. She pointed to domestic investments being made to establish semiconductor manufacturing as evidence that India was 'no longer a laggard' in frontier technologies.

However, she issued a stark warning about capital movements. "Continued capital outflows are one of the biggest risks for India in 2027," Sitharaman said, identifying record foreign investor outflows as a key threat for the coming year.