FII exodus: Here is what it will take to make Indian equities attractive to foreign investors again

The NIFTY50 index has dropped nearly 5.9% and the 30-share SENSEX has dived 5.87% in September multiple factors have contributed to the sharp selloff in Indian equity markets. Rising crude oil prices in global markets have raised concerns over inflation and corporate profitability, while a surge in US Treasury yields has increased the attractiveness of dollar-denominated assets for global investors.

At the same time, expectations of a potential rate hike by the Reserve Bank of India have added to concerns over borrowing costs and economic growth. The pressure has been further intensified by foreign institutional investors turning net sellers in Indian equities during the month, leading to increased selling pressure across the market.

FIIs have sold shares worth ₹25,662 crore in the Indian markets so far in September, reversing the net buying of ₹49,831 crore recorded over the previous two months, according to data from the National Securities Depository Limited (NSDL).

The renewed selling by FIIs coincided with a sharp rise in US Treasury yields, with the 10-year bond yield climbing to 5.24%, its highest level since 2007. The surge in yields made US government bonds more attractive to global investors, prompting a shift in funds away from emerging markets such as India towards relatively safer US assets.

Global investment firm Bernstein earlier this week said that FIIs have little reason to invest in India. However, they may return to trade in Indian equities rather than invest for the long-term.

FPI flows are likely to remain the more volatile component of the financial account contingent on US Fed expectations, global risk appetite, AI-led investment themes and USD/INR dynamics, National Stock Exchange (NSE) said in its September Market Pulse report.

What should be done to restore FII confidence?

Restoring confidence for FIIs in Indian markets requires a combination of sustained corporate earnings growth, reasonable valuations, currency stability and a predictable policy environment. Improving domestic consumption, reviving private-sector capital expenditure and accelerating infrastructure development can strengthen earnings visibility and make Indian equities more attractive to global investors, analysts noted.

The government and market regulators can also help by ensuring tax and regulatory stability, simplifying foreign investment procedures, reducing compliance costs and improving market liquidity. Maintaining fiscal discipline, managing inflation and strengthening external balances would help reduce macroeconomic risks, while greater currency stability could protect dollar-denominated returns.

"Tax certainty is the first: capital gains and transaction-tax treatment that does not change with every Budget, because the one thing a long-only allocator cannot model is a rule that moves. Regulatory predictability is the second, specifically a consultation calendar on derivatives and market-structure changes so that positions are not repriced by surprise," said Anirudh Garg, fund manager at Invasset PMS.

Rajesh Singla, fund manager and CEO of Alpha AMC noted that selling is mostly driven by global factors like crude above $100, US yields at multi-year highs, and a strong dollar.

"Three things will help the most. First, earnings growth that justifies India's premium valuations, since margins are under pressure right now. Second, policy stability and a steady rupee, so global funds can plan with confidence. Third, more quality IPOs and deeper capital markets, so foreign investors have more to own beyond large caps," Singla told Upstox.

Valuations have also turned more reasonable after the recent correction, and that is often what brings foreign money back, he added.