FII sell-off: Here’s how rupee depreciation eating away FIIs profit

Foreign investors have pulled out close to ₹3 lakh crore from Indian equities on a net basis since October 2024, causing a major correction in the stock markets. Benchmark BSE SENSEX has retreated nearly 12% and NIFTY50 by 10.7% from the all-time highs scaled in the last week of September.

Multiple factors have triggered heavy sell-offs by foreign institutional investors (FIIs), including high bond yields in the US, higher valuation of Indian equities, sluggish quarterly results and macroeconomic conditions and most recently, global uncertainties and trade war concerns over the trade tariff announced by US President Donald Trump.

The flight of foreign capital has also caused ripple effects on the rupee’s value against the US dollar, dragging it down by nearly 4% since October 2024. Though the rupee depreciation is not one of the key reasons for the FII sell-off, the reverse is true for the Indian currency.

According to experts, FIIs who entered Indian markets during the corrective phase (during October 2024) find a weak rupee a major hindrance to their exit.

Suppose a foreign institutional investor (FII) entered the Indian market on January 1, 2024, with a $1,00,000 investment. At the prevailing rupee exchange rate (₹83 vs USD), the value of the investment stood at ₹83,00,000 (₹83 lakh)

In February 2025, the investor wanted to exit the Indian market with a return of around 6%, which the NIFTY50 has given since January 1, 2024.

The investment value would have turned into ₹87,98,000, and the net returns could be around ₹4,98,000. After the deduction of capital gains tax at 10%, the net gain for the foreign investor will be around ₹4,48,200.

So, the total investment made by the foreign investor in January 2024 would have turned into ₹87,48,200 after the deduction of taxes.

In dollar terms conversion, the investment would have turned into $1,00,611.84 as per the current rupee exchange rate at 86.95, leaving just $611.84 in the hands of the foreign investor. This indicates a gain of meagre 0.61% compared to a 6% rise in the benchmark SENSEX during the investment period.

In comparison, the investor could have earned risk-free returns of more than 4.5% had the money been invested in US bonds.

Some experts may argue that FIIs may use forward contracts and other derivatives to hedge currency risk to overcome the above scenario. But currency hedging also comes with its own cost (around 1-3% ), and many investors may be unable to time it to perfection. In any case, rupee depreciation is taking a toll on FIIs profits.

In addition to rupee depreciation, rising US yields, global slowdown fears, and valuation concerns are other valid reasons for FIIs to pull out funds from domestic markets.

Rebound in US bond yields

The rebound in US bond yields to over 4.5% in recent months due to US elections, geopolitical worries and surging inflation have made US investment attractive and risk-free in comparison to riskier emerging markets. A fall in emerging market currencies like rupee due to appreciation in the US dollar has reduced returns for foreign investors.

Undervalued Chinese markets

A rebound in Chinese shares following euphoria around DeepSeek and other AI ventures has made the stocks attractive. The Chinese government has also taken proactive steps, such as economic stimulus, which has given a boost to stock market sentiment, triggering a flight of investment from India to China.

The declining rupee has reduced the gains of FIIs, who are exiting the Indian markets, to lucrative destinations like China. The foreign inflows into Chinese equities have increased in recent weeks amid the positive sentiment over the release of DeepSeek’s AI technology, which is being seen as a low-cost option over its US counterparts like ChatGPT.

According to reports, Chinese software companies' stocks rallied around 38% in two weeks following the release of DeepSeek’s (DS) R1 model. China’s onshore and offshore equity markets added more than $1.3 trillion in value in the last month.

Higher valuations

Indian stock markets received huge FII inflows until September last year. The increased participation of domestic investors also inflated the valuation of Indian stocks, making them pricier than Asian markets like China.

FIIs like active mutual fund managers who entered Indian stock markets two or three years ago are booking profits now due to higher valuations. According to experts, the returns, despite the rupee fall are still upwards of 28%.