Turning The Tide: Fixing India's FII Exodus

You have read and seen all over conventional media that FII's are ditching the Indian market for better opportunities especially the Asian Peers to invest in AI/Data Centre theme such as Taiwan or Hong Kong. Even the are gravitating towards China because the valuation is quite cheap as compare to India.

As of mid 2025, the Nifty was trading around 22-23x forward PE, while China (10-11x), Hong Kong (7-8x), and Indonesia (11-12x) offer significantly cheaper entry points. Earlier when the valuations were attractive in India the FII's followed “Sell China, Buy India” but now they have reversed this to “Sell India, Buy China”.

This is apparent in the return of the markets on YTD basis Nifty has return of -9.1% while South Korea leads and has a YTD return of 55%, followed by Taiwan which delivered YTD return of 48%, Brazil gave a 9.1% return, China has -5.2% return, Hong Kong has -5.22% return.

When global macro pressures rise (such as high U.S. bond yields, a strong dollar, or shifting global themes like the AI infrastructure trade), stretched Indian valuations trigger aggressive FII outflows. Domestic Institutional Investors (DIIs) absorbed sell-offs, providing market support, while FIIs recalibrated their exposure amid stretched valuations in developed markets.

Muted Earnings:

India’s corporate earnings have underwhelmed across four consecutive quarters, with Nifty 50 earnings growth slowing to just 3-4% YoY in Q2FY26, along with this weak topline growth, margin compression due to input cost inflation, and subdued consumer demand have eroded investor confidence.

Depreciating Currency:

INR has been depreciating at an alarming rate so much that its difficult for the FII's to maintain that along with it there aren't hedging mechanisms to protect that, we have discussed this in detail you can check it out here.

High Taxes & Populist measures:

The Budget 2025 prioritised direct tax cuts and welfare spending over infrastructure capex. This shift has raised concerns about long-term growth sustainability. With capex momentum slowing and fiscal risks rising, foreign investors are reassessing India’s medium-term growth trajectory and reallocating to more policy-stable markets.

The Government in mid 2024 increased the Long Term Capital gains tax to 12.5% from 10% that's a steep 25% increase and increased the Short Term Capital Gains Tax to 20% from 15% that's a 33% increase along with this they have increased the STT on Options and Futures and exercising options.

Futures Contracts: Increased from 0.02% to 0.05% of the transaction value (charged on the sell side).

Options Premium: Increased from 0.10% to 0.15% of the premium received (charged on the sell/short side).

Exercised Options: Increased from 0.125% to 0.15% of the intrinsic value (charged on the buyer side).

The Futures and options were being used by the FII's as a hedging instruments and now they too become expensive, so due to increase in the taxes is one of the key reasons behind the FII exodus.

The Possible Reversal

There is a silver lining to every story but to achieve that silver lining you need to work on the solutions, so let's discuss what India can do to reverse this.

1. Macro & Currency Stabilization

INR is too much volatile and it has a history of very high depreciation, so first we need to stabilize the INR around 90 levels for the time being then we need to take capital measures so that the INR maintains 90 levels or appreciates a bit much. The FII's should have the option to hedge the currency

For INR to be stable we need to have a mix of short-term actions and long-term structural reforms. For short term structural reforms we can curb the import of non-essential items. Option for Vocal for Local approach, recently you have heard Indian government put a restriction on the gold imports this was done to support INR.

We can make numerous short term reforms but Long term reforms is the key, to stabilize the rupee it includes focussing on increasing the Exports of our country, for that we need to be competitive in the international market so naturally we would need to increase our spending on R&D and spend on infrastructure rather than handing out freebies.

2. Earnings-Justified Valuations

For an investor valuation is a core thing and as we have discussed above Nifty is kind of expensive for us to be attractive we need consistent double-digit earnings growth matching the premium multiples. This would put us on favorable relative valuations compared to alternative emerging markets (e.g., China, Brazil, Indonesia).

3. Policy Predictability and Tax Rationalization

Raising Taxes is not favorable, we need to have a stable TAX system and the government should refrain from increasing further taxes on the capital markets in any shape of form. 

FIIs pulling out funds to optimize tax liabilities or escape tightening margins cause sharp, sudden outflows. Recently RBI tightened the margin regulations and for that we saw a drop in volume in the capital markets.

Conclusion:

Reversing this exodus requires a decisive, two-pronged strategy: aggressive short term macro stabilization and long term reform anchoring the rupee and easing hedging of Rupee coupled with long-term structural reforms focussing on export competitiveness, R&D, and tax predictability. If India can successfully recalibrate its fiscal policies, reward fundamental earnings growth, and restore investor confidence, it can transform this temporary cyclical setback into an opportunity for a more resilient, mature, and sustainable economic future.