Market participants are expecting a turnaround in the coming year after Indian equities witnessed the highest-ever foreign fund outflows in 2025. Their expectations hinge on a trade deal with the US, policy reforms and the investor behaviour towards overvalued AI stocks.
In 2025, foreign investors net withdrew Rs 1.53 lakh crore from equities as of December 26. This was driven by rising US bond yields, a stronger dollar and capital reallocation towards developed markets and regions, such as China, Taiwan and South Korea, benefiting from AI- and semiconductor-led growth, according to a note from Motilal Oswal. Muted corporate earnings growth also contributed to outflows from sectors like IT and FMCG, it said.
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Jitendra Gohil, chief investment officer – listed equities, Bajaj Alts, attributed the market’s underperformance to other countries to valuation concerns, excess supply of equity, and prolonged trade tensions with the US. Moreover, Indian equities offered limited exposure to the AI-driven boom that benefited Chinese, Taiwanese, and Korean markets. India remained somewhat isolated as Thailand, Vietnam, Malaysia, Pakistan, and even Bangladesh managed to secure lower tariffs from the Trump administration.
Why India Lagged Behind Asian Peers in 2025
Improving earnings visibility, supportive policy measures and the potential turnaround in FII flows create a favourable backdrop for Indian equities in 2026, said the Motilal note.
Saurabh Mukherjea, founder and CIO at Marcellus Investment Managers, believes if the rupee keeps falling, foreign investors will stay away. Until Trump signs a trade deal with India, this dynamic will keep pushing the rupee lower. Resumption of FPI flows, especially into large-caps, can be expected when the rupee stabilises, he said.
“Looking ahead, expectations of US Federal Reserve rate cuts in 2026 could support renewed FII inflows into emerging markets, including India,” Motilal’s note said.
Interest Rates and the Rupee Pivot
However, Shankar K, a Sebi-registered investment advisor, said: “I maintain a contrarian view on FII flows over the next 6–12 months. As US interest rates are expected to decline sharply during this period, foreign investors are likely to channel more capital into US debt, rather than in emerging markets. Falling yields could deliver meaningful capital gains in bonds, while investing domestically also helps investors avoid currency risks. These factors may keep FII inflows into markets such as India muted in the near to medium term.”
Gohil said some profit-taking in AI-related stocks may occur, triggering rotation into Indian equities. “It is likely that India may eventually sign trade agreements with the US and Europe in the coming months,” he said.
Divam Sharma, co-founder and fund manager at Green Portfolio PMS, said: “As global interest rates peak and expectations of easing build, the risk appetite for emerging markets like India is likely to improve. Strong forex reserves and policy continuity further enhance the investor confidence. The upcoming Budget is expected to focus on niche, future-oriented sectors such as drones, defence manufacturing and capital equipment, strengthening India’s industrial ecosystem. While valuations remain elevated, India’s long-term growth visibility and earnings resilience continue to make it a preferred destination for global capital.”
The Nifty and Sensex are at 21st and 23rd position, respectively, in terms of dollar returns among the 26 Asian emerging market indices, having delivered 3.7-5% in 2025 year to date, compared to 76% from South Korea’s Kospi and 35% from China’s Shenzhen Component index.