Foreign institutional investors (FIIs) have been aggressively selling Indian stocks in the cash segment since July. From July 1 to September 8, they offloaded Indian shares worth over ₹1 lakh crore on stretched valuations, weak earnings and uncertainty over Trump tariffs.
Foreign capital outflow is the key reason why the Indian stock market has been stuck in a range since July, despite robust buying by domestic institutional investors (DIIs) amid a healthy macro outlook of the country. Domestic institutional investors (DIIs) have been consistently net buyers in the cash market since August 2023.
Why are FIIs selling Indian stocks?
The relentless selling of FIIs can be attributed to the following five main factors:
1. Weak earnings
Overall weak earnings growth for the last several quarters acted as a key trigger, prompting foreign investors to go on a selling spree in the Indian equity market.
The Nifty saw single-digit earnings growth for the fifth consecutive quarter since June 2020. According to estimates of brokerage firm Motilal Oswal Financial Services, the Nifty delivered 8 per cent year-to-year (YoY) PAT growth for Q1FY26.
“The Q1FY26 earnings have broadly been in line, with the severity of earnings cuts moderating compared to the previous quarters, albeit the trend of a higher number of downgrades continues into this quarter,” said Motilal Oswal.
“EPS growth for Nifty 50 is projected to rise to nearly 9 per cent in FY26 versus an anaemic 1 per cent in FY25, aided by a likely improvement in the macro environment owing to the stimulative fiscal and monetary measures,” the brokerage firm added.
2. Stretched valuations
Weak earnings created an earnings-valuation mismatch, driving foreign investors to other, cheaper emerging markets. After some correction, the valuations of large-caps came near their long-period average, but small and mid-caps remained stretched in August.
“The Nifty 50’s one-year forward P/E stood at 20.6 times, near its long-period average (LPA) of 20.7 times. In contrast, the Nifty Midcap-100 and Nifty Smallcap-100 indices are trading at 26.1 times and 24.9 times, representing premiums of nearly 14% and 50% to their respective LTAs. Meanwhile, India’s market cap-to-GDP ratio remains high,” said Motilal Oswal.
3. Trump’s tariffs
US President Donald Trump has imposed a cumulative 50% tariff on Indian goods, further worsening the market outlook. The impact of these tariffs will depend on how long they remain in place. If they persist through the entire financial year, India’s GDP growth could decline by 60–80 basis points.
The recent GST reforms could mitigate the tariff pain significantly, but the uncertainty factors in US tariffs are a bigger negative.
4. Gains in the US dollar
The dollar index has climbed over 1 per cent since July, further exerting pressure on emerging markets like India.
A strong dollar impacts foreign capital inflows in several ways. Since a stronger dollar means a weak rupee, FIIs’ returns in dollar terms shrink when they convert rupee earnings back to dollars. Moreover, the dollar’s rise causes bond yields to rise in the US, making FIIs pull money out of emerging markets and move it into US assets.
5. Elevated interest rates in the US
The US Federal Reserve has maintained interest rates in the 4.25%–4.50% range since last December, citing persistent inflation risks. Elevated rates keep borrowing costs high while making US bonds and the dollar more attractive. As a result, they often trigger FII outflows from emerging markets such as India.
Is there more pain ahead?
The outlook for the Indian stock market appears healthy in the wake of GST reforms, which are expected to boost consumption and keep the economy in fine fettle. Earnings growth, valuation comfort, and the start of the US rate reduction cycle are also expected to create favourable conditions for the Indian stock market.
G. Chokkalingam, founder and head of research at Equinomics Research Private Limited, believes FIIs will likely return after the October quarter, provided the US does not disrupt India’s IT services exports.
“Direct and indirect tax reforms, a good monsoon, robust agricultural growth, low inflation, potential rate cuts, lower crude oil prices, and an earnings revival—expected from the December quarter—will further support FII inflows,” said Chokkalingam.
Ajit Mishra, SVP of research at Religare Broking, said FIIs are selling because other markets are performing better and are more reasonably valued.
He said once we start seeing an earnings recovery—by the next quarter or perhaps by the fourth—we may witness a sustainable reversal in FII trends.
Ross Maxwell, Global Strategy Lead at VT Markets, believes the GST reforms are a key factor that can attract FIIs to the Indian markets.
“The GST reforms will boost investor confidence, as they signal policy stability and a stronger commitment to reforms. For FIIs, the simplification of GST will be seen as encouraging. It strengthens the ease of doing business, ensures better earnings visibility for companies, and supports long-term consumption growth by potentially reducing the tax burden on goods and services. These factors will improve India’s attractiveness as an investment destination,” said Maxwell.
However, while reforms like GST are positive, they are not the only thing that FIIS will consider.
Maxwell underscored that FII flows are also heavily influenced by other global factors such as US interest rates, the strength of the US dollar, and risk appetite. So, whilst the reforms alone are positive, they are just one factor to consider.
“Overall, this reform adds to India’s credibility as a high-growth economy that is open to reform. FIIs are likely to take note, but their return will depend on both India’s continued reform momentum and broader global financial conditions,” said Maxwell.
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