Why global capital is turning cautious on India

Foreign portfolio investors (FPI) have pulled about Rs 2.1 lakh crore out of equities between January and early May 2026, based on data from NSDL, with several reports describing this as the sharpest year-to-date outflow since foreign portfolio investing in equities was permitted in 1993. The selling has come even as domestic mutual fund inflows have remained robust, with monthly SIP contributions crossing Rs 31,000 crore in recent months according to data from AMFI. This divergence highlights an important shift in markets where domestic investors are increasingly cushioning volatility, while foreign capital continues to influence valuations, liquidity, and broader market sentiment. How long a domestic buffer can hold without meaningful overseas participation is the question which now sits at the centre of every market conversation.

The scale of the reversal is striking when set against recent history. NSDL data shows FPIs poured close to Rs 1.71 lakh crore during calendar year 2023, but momentum weakened materially through 2025 before turning into aggressive net selling in 2026 and YTD outflow already exceeding the full-year outflow recorded in 2025. In the meantime, the country is expected to remain among the world’s fastest growing major economies, with the International Monetary Fund’s latest World Economic Outlook estimating GDP growth at around 6.2% for 2026, significantly ahead of the US at 1.8%, the Europe at roughly 1%, and the global projection of 2.8%. Financial markets, however, do not allocate funds based purely on growth differentials, and relative valuations, interest rates, currency movements, and global liquidity conditions all matter equally and often more immediately than headline GDP numbers.

For much of the post-pandemic period, India became one of the most favoured emerging markets as political continuity, expanding retail participation, rapid digitisation, and a strong domestic consumption story attracted substantial inflows. Such optimism also pushed valuations sharply higher, and by late 2025 benchmark indices were trading at noticeable premiums both to other emerging markets and to their own historical averages. At the same time, the global monetary environment turned less favourable, with the US 10-year Treasury yield remaining above 4.3% for extended periods through 2025 and 2026 and briefly testing higher levels during phases of stress. When relatively safer US government securities offer yields above 4%, global investors reassess exposure to riskier emerging market assets, particularly those trading at premium valuations relative to their own history.

The strength of the US dollar added pressure, the rupee, which traded at around Rs 83 per US dollar in early 2024, has weakened considerably and touched a record low close to Rs 97 in May 2026 before RBI intervened to stabilise it. For external investors who measure returns in dollars, this kind of currency depreciation significantly erodes realised gains once profits are converted back, and this effect becomes especially relevant during periods of global risk aversion, when institutions tend to gravitate towards dollar assets and developed markets. Crude oil prices, lifted in recent quarters by sanctions on Russian supply and the escalation involving the United States, Israel, and Iran, have further complicated the picture, since nearly 85% of crude requirements are imported and economy is structurally exposed to energy shocks. Higher crude prices feed directly into imported inflation, stress the current account deficit, and complicate the Reserve Bank’s rate trajectory, all of which weigh on FPI sentiment toward emerging markets.

Layered on top of these cyclical weights is a structural shift in how globally money is being allocated. Over the past two years, a disproportionate share of institutional flow has gravitated towards artificial intelligence linked sectors, semiconductor manufacturing ecosystems, and large United States technology companies. Investment has increasingly concentrated around firms participating directly in the AI infrastructure cycle, and while the long-term digital opportunity remains substantial, near-term visibility into a comparable domestic theme is relatively weak. Global investors have therefore allocated significant outlay towards companies linked more directly to semiconductor fabrication, advanced computing hardware, and AI cloud infrastructure, much of which sits outside the listed universe.

With all of this in the background, what is striking is there has been no rout which accompanied previous episodes of selling. Domestic institutional investors have absorbed a substantial proportion of foreign selling through 2026, supported by the steady expansion of systematic investing, rising retirement savings participation, and the deepening of retail ownership across direct equity and mutual funds. This shift represents a meaningful evolution in investment landscape over the past decade and has been the principal stabilising force during the current bout of volatility, although it is worth noting the resilience of retail flows and SIP contributions has not yet been seriously tested against a sustained and sharp market correction.

None of this means foreign capital has become irrelevant. Domestic and foreign investors play separate roles within financial markets, with former providing stability and absorbing volatility during periods of stress, while later play a meaningful role in valuation expansion, global market perception, and the depth of liquidity in large benchmark stocks. Sustained premium valuations are difficult to maintain without meaningful foreign participation, particularly in index-heavy companies where global institutional ownership remains significant, and sustained inflows from abroad also serve as an external validation of a country’s growth story, economic policies, and broader macroeconomic resilience.

When the tide turns will depend largely on how the global cycle, and the United States economy in particular, evolves from here. A moderation in Treasury yields, a softer dollar, or a clearer cooling in global interest rates would meaningfully improve the relative attractiveness of emerging markets. Oil will remain equally important, given how directly imported energy feeds into inflation and the rate trajectory, and corporate earnings growth will eventually have to grow into the valuations the market continues to demand.

The present phase, therefore, does not represent a collapse of the economic story, which continues to be among the more robust, rather it reflects the everyday reality of global markets, where flows continuously recalibrate around relative opportunity, macroeconomic conditions, and perceived risk. While India is structurally far better positioned today than during previous episodes of capital flight, the current outflow cycle is a useful reminder that, in a deeply interconnected financial system, growth alone is not sufficient. History suggests the same global cycle which pulls capital away from emerging markets tends, in time, to bring it back, and the periods in between have often been the ones in which long-term domestic ownership of Indian equities has quietly deepened. Whether the current cycle will follow a familiar pattern, and on what timeline, will ultimately be determined by forces well beyond Indian shores, even as the underlying economic story at home continues to do much of the heavy lifting.

(The writer is Managing Partner at Aryzen Capital Advisors)