Foreign investors are fleeing India’s stock market — but analysts see long-term potential

Indian equities have been sliding since September, as foreign investors spooked by a slowdown in the country’s economy exit their holdings. Analysts see this as a “healthy correction.”

India’s benchmark stock indexes the Nifty 50 and Sensex are hovering at more than seven-month lows, firmly in correction territory since their September high.

Sectors such as real estate, energy and autos have been the biggest decliners, data from Goldman Sachs showed. 

This development comes as a stark reversal from last year, when the Nifty 50 consistently notched record highs, and outperformed the S&P 500 for the greater part of the year.

“The bubble was long building, but acknowledgement is recent,” said Venugopal Garre, head of India research at AB Bernstein. He attributed the gloomy outlook to a mix of sluggish earnings and weak economic growth in India’s second fiscal quarter.

India’s gross domestic product expanded by 5.4% in the quarter ended September, marking the slowest growth rate in the past seven quarters. The government recently lowered its economic growth estimates for the fiscal year ending March to 6.4% — the lowest in four years. 

“After a stellar run, India’s economy has entered a softer patch that will continue for a few more quarters,” data and analytics firm Capital Economics said in a recent note.

“We think that will portend an underperformance in local equities relative to other major benchmarks,” wrote Harry Chambers, assistant economist at Capital Economics.

HSBC earlier this month downgraded its rating on Indian equities to “neutral” from “overweight.” The bank also cut its Nifty 50 earnings growth forecast for fiscal year 2025 to 5% from 15%.

Foreigners have been net average sellers of Indian equities over the last four months, according to data from India’s National Securities Depository, as the country’s growth falters.

Foreign portfolio investor flows into Indian equities plunged by 99% to just $124 million in 2024 compared with the year before, the data showed. 

The outflows have increased sharply in the past few weeks, with foreign investors withdrawing about $8.3 billion from Indian equities as of Jan. 28.

Foreigners remain net sellers of Indian equities, said James Thom, senior investment director at Abrdn. There has been a rotation out of India and emerging markets stocks into U.S. equities, Thom added.

“Foreigners have been largely absent from the India story in the past year,” he told CNBC.

“It’s a sort of risk-adjusted view that [investors] can get a better, safer return in U.S. equities,” Thom said. “So why take the risk, so-called perceived risk with India?”

India’s economic slowdown also comes at a time when U.S. Treasury yields have been gaining momentum, leading to unprecedented outflows of FPIs, said Rana Gupta, managing director at Manulife Investment Management. Higher Treasury yields tend to take investments away from the stock market as bonds become more attractive.

Profit booking by foreign institutional investors has also pressured India’s equity markets.

“When a market does so well for such a long period of time, there is a lot of profit in the portfolio,” Nilesh Shah, managing director of Kotak Mahindra Asset Management, told CNBC.

“This profit booking by the FPIs is resulting in higher supply at lower prices resulting in bidders dropping their bids, leading to correction,” he added.

Profit booking involves selling a portion of an investment to secure gains after the asset has risen, rather than holding it indefinitely. Traders sometimes engage in profit booking when the stock or asset is believed to be overvalued or have hit a peak.

Some of the foreign portfolio investors who have made large profits in Indian equities are tempted to book more profits looking at higher valuations, Shah added.

In contrast with the exodus of foreign money, India’s local investors have continued to pile into the Indian market, partially stemming what could have been a deeper decline in equities. 

Domestic investors have funneled in around $27 billion in Indian equities since October, data provided by Manulife showed.

The quadrupling of domestic equity investors in India between 2020 and 2024 has led to a mini-bubble, which has been deflating since September, said Praveen Jagwani, CEO of asset management company UTI International.

“The onslaught of tens of millions of retail investors into stocks with questionable fundamentals has driven up valuations in India,” added Jagwani. “For sustainable equity growth, a healthy pullback is needed.”

While the near-term outlook for Indian equities may look bleak, some analysts believe longer-term fundamentals remain solid, and that a rebound is in the works.

“Indian equity markets are going through a cyclical consolidation after four strong years of returns post Covid,” said Pramod Gubbi, co-founder of Marcellus Investment Managers. “I would see this as a healthy correction.”

Gubbi added that if valuations become more reasonable as a result of the sell-off, it could attract a new set of investors, who have stayed on the sidelines because of valuation concerns.

“In 2023 and 2024, the Indian equity markets galloped ahead a bit too quickly and the current correction is a healthy mean reversion,” echoed UTI International’s Jagwani.

The Nifty 50 saw an annual return of almost 9% in 2024, and around 19% in 2023.

Abrdn’s Thom said that while there’s a bit of pullback in the near term, he sees “great opportunity” for investors in India in the longer run, especially in the domestic IT and private banking sectors.

While speculators may focus on quarterly fluctuations in the economy, Kotak’s Shah said long-term investors need not be worried: “[It’s] Speculator’s nightmare, investor’s delight.”