FPIs Are No Longer The Driving Force Of The Stock Market

FPIs have been an integral part of the Indian stock market ever since they were allowed to operate from 1991 to 92 onwards. They have generally been bullish about the Indian economy, as seen by the total assets under custody of $735 bn as of March 2026. The importance is felt, as often movements in the stock indices have been associated with their net inflows. On the debt side, the interest in government paper has increased ever since Indian bonds were included in the JP Morgan Government Bond Index-Emerging Markets, which was followed by other such announcements by FTSE and Bloomberg. With India retaining the tag of the fastest growing economy for three successive years, it would be expected that FPI inflows would increase continuously.

The FPI flows have been negative this year so far in the first 7 months at -$11.8 bn, with equity being -$16.9 bn. The debt has been positive, thus lowering this gap. Interestingly, the net equity outflows have been concentrated in a set of sectors, which would normally be considered to be relatively more attractive. The highest outflows were witnessed in financial services ($6.6 bn), followed by oil and gas ($4.4 bn), auto ($3.4 bn), FMCG ($2.7 bn), telecom ($2.4 bn), and power ($1.0 bn). The inflows have been positive in sectors such as services, consumer services, and durable goods, with inflows of above $1 bn.

The net outflows are significant and a puzzle, considering that company results have been very positive, with the Q2 numbers being even more promising than the Q1 performance. One reason often quoted for the withdrawal of the FPI was valuation. The story in 2025-26 was that Indian stocks were overvalued with the result that the potential upside was restricted, which led to funds pulling out. When valuation is felt to be higher, the only way to retain interest is in better financial performance. This has been accomplished this year, and, hence, the valuation reason may not be a convincing argument here.

It is in this context that the factors driving such flows need to be looked at closely. On the supply side, the overall quantum of investible funds has come down ever since the central banks in the West have rolled back on easy liquidity. The increasing interest rate cycle being witnessed today makes debt investors look at Western markets more closely, as they become viable alternatives for portfolio diversification. This is where interest rate differential matters. Presently, Indian bonds have a yield of, say, 7.30% for 10 years, while the comparable return on US treasuries is around 5%. The differential does not address the conventional depreciation of 3-4% witnessed in the rupee over a long-term period. This is on the debt side.

Further, with these countries beating the war syndrome and performing well on growth, prospects open up further for investment in the equity segment. The economic growth, too, has tended to be better than expected in Western markets, leading to heightened interest shown by investors. Also, stock indices across the world have delivered higher returns in the last year, and the lower performers were India and Indonesia. Hence, there is again reason for investors to rebalance their portfolio and move over from underperforming markets to ones with higher potential. This becomes important when the overall quantum of investible funds does not grow as before.

An interesting development, however, is that, notwithstanding the withdrawal of FPIs, some of the sectoral indices have done better than the benchmark indices. For example, the auto index was up by 6.4% in the first 7 months, while financial services were up by 5.8%. Telecom registered a 36% increase. Therefore, there is no longer a direct correlation of movement in stock prices with the FPI activity. This is so as domestic institutional investors (DIIs) have now occupied the space of prime drivers. Within this category, mutual funds have taken the lead role, followed by insurance companies, pension funds, and AIFs.

The dominance of DIIs is a reflection of the maturity of the market. The DIIs are investing funds that have been put in by the final customer, which can be retail or corporate. As mutual funds and pension funds run schemes that have specific targeted sectors across both equity and debt, such funds tend to get invested in the relevant stocks. As the level of awareness increases, which has been quite steady over the years, there will be more such investments. Mutual funds have already witnessed an upsurge in terms of the flow of funds into both the equity and debt sides, with the latter being more concentrated in the hybrid schemes. As retail interest keeps increasing in the market, the mutual fund route will be used to increase exposure.

A possible message here could be that the FPIs may no longer be the driving force of the stock market, though their contribution is significant and important. It is definitely necessary to ensure that the rules of the game are hospitable for their operations, which is what the policymakers have been continuously doing (the latest being the withdrawal of withholding tax on debt investments). But these flows would continue to be critical from the point of view of balance of payments. Withdrawal of funds has a strong correlation with exchange rate movements, and, hence, ensuring that these flows come in is important from the point of view of the capital account.

Interestingly, in the last couple of years, the rupee has come under pressure more due to the capital account becoming weak rather than the current account, which had held up well in turbulent times. Higher FPI flows would certainly help strengthen this account and, hence, steady the rupee. Therefore, addressing concerns regarding balance of payments would be a more compelling argument than boosting stock markets.

The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.