Much before Bernstein downgraded its stance on Indian equities in early January, foreign portfolio investors (FPIs) had already begun voting with their feet. Through 2025, FPIs found better opportunities elsewhere—betting on markets in China, Korea, and the US, and being handsomely rewarded. In the process, they pulled out nearly $19 billion from Indian equities. The trend appears to have spilled over into 2026, with outflows so far of around $3 billion. The disenchantment is not primarily about the rupee’s depreciation or geopolitical risks. It stems instead from a slowing economic momentum, limited headroom for further fiscal stimulus, the absence of strong catalysts to lift corporate earnings, and persistently expensive valuations. Over the past few years, the government has done most of the heavy lifting—supporting growth through tax cuts and a sharp increase in capital expenditure.
Exhausted Levers
That support now faces constraints. With economic growth—and more importantly nominal GDP—slowing, the government has limited room to provide fresh stimulus as it remains committed to fiscal consolidation. At the same time, private corporate investment has stayed hesitant, with companies citing weak demand visibility. Stronger investment would have helped generate jobs and revive consumption, but that impulse has yet to materialise. Monetary easing, too, has had a muted impact. Despite the Reserve Bank of India cutting policy rates by 125 basis points, credit has not become meaningfully cheaper except for select borrower segments. Banks have struggled to mobilise retail deposits, keeping loan growth modest. India Ratings expects credit growth at shadow lenders to moderate to 15-16% next year as they turn more selective following stress in the micro, small, and medium enterprise sector. Economists now see GDP growth in FY27 settling around 6.7-6.8%.
An India-US trade deal, or interim tariff relief, could provide a fillip to exports, jobs and incomes. Until such a deal materialises—and on terms favourable to India—export momentum is likely to remain under pressure. Against this backdrop, India entered 2026 as one of the world’s most expensive equity markets, trading at over 20 times one-year forward earnings, compared with an average multiple of about 15.1 times across 15 major economies. While the recent market correction has made valuations marginally more reasonable, corporate earnings this season have also been soft. Despite cuts in income tax and goods and services tax rates, consumption demand remains tepid, as reflected in subdued earnings at Reliance Retail, Shoppers Stop, and Avenue Supermarts, and provisional data from fashion retailers such as Trent.
Valuation Trap
With the impact of the new wage code rules yet to fully play out, earnings growth may remain stuck in high single digits. That, combined with a heavy primary market pipeline that could cap secondary-market returns, has kept FPIs cautious. Returns from benchmark indices between July 2004 and January 2026 have been mediocre, while small-cap funds delivered negative returns between June 2024 and December 2025. Indian equities also continue to trade at a premium to most global markets. Even after recent corrections, valuation multiples remain well above those of several markets—making India a tougher sell in a world where investors are increasingly price-sensitive. The retreat of FPIs is, however, less about losing faith in the long-term India story. For them to regain confidence in the India story, what is needed is not narrative optimism but a clear improvement in the quality and durability of corporate earnings. That revival, for now, appears some distance away.