Since the Iran conflict began in late February, foreign institutional investors (FIIs) have pulled out a whopping $19 billion—about ₹1.78 lakh crore—from Indian equities, causing the Nifty to fall more than 9% from its 52-week high. A market that was once one of the world’s favorite emerging markets has rapidly turned into a “no-go” zone; The reason for this is the rapid exit of global capital amid rising energy prices. Although this sharp market correction has brought valuations to reasonable levels, institutional desks are not yet signaling a period of “strong buying”. Instead, there is a palpable sense of unease as the financial equations for dollar-based investors have gone haywire.
Market data from Elara Securities shows that India remains an exception among emerging markets as selling pressure from FIIs continued for the fifth consecutive week. In contrast, foreign investors continue to pour capital into other emerging markets. Let’s take a look at the seven main factors that are creating a lot of concern among stock market investors about the Indian market at this time:
Factors causing concern among foreign investors*
**Ceasefire: Just an Illusion:** Two weeks of peace in the Iran-US conflict did bring some momentum to the markets; However, institutional investors do not consider this a turning point. Foreign institutional investors (FIIs) consider this pause strategic rather than diplomatic. Given the looming threat of a blockade and the growing risk of a second phase of the conflict, global funds are maintaining a neutral stance until a long-term solution is formally signed. In market parlance, this is considered a momentary surge—a fact that savvy investors understand all too well.
**Crude Oil: The “Twin Deficit” Time Bomb:** With Brent crude prices approaching the $100 per barrel mark, this situation poses not only an energy challenge for India but also a major threat to macroeconomic stability. FIIs are well aware of the ‘twin deficit’ trap: higher oil prices widen the current account deficit and also fuel domestic inflation, putting pressure on the Reserve Bank of India to raise interest rates—just when the economy needs relief most.
Risk premium reduced: The investment calculation for foreign investors has completely changed. As the US 10-year Treasury yield approaches the 4.5% mark, the risk premium associated with investing in Indian equities has declined sharply. This challenge has been further compounded by the weakening of the rupee; Recently, the currency had reached the mark of 95 against the US dollar.
Other markets are offering higher returns: Compared to other emerging markets, India is currently offering very low returns to foreign investors. Markets such as South Korea and Taiwan are considered more attractive from a foreign investor perspective, as earnings growth expectations in these countries—especially for FY27—are much higher than the relatively modest projections for India.
India’s tax regime: another hurdle: India’s changing tax regime is now being seen as a structural hurdle. In the Union Budget 2024, the short-term capital gains (STCG) tax rate was increased from 15% to 20%, while the long-term capital gains (LTCG) tax rate was increased from 10% to 12.5%. When this is combined with the changes in the LTCG/STCG structure and the increase in Securities Transaction Tax (STT) to be implemented from FY27, the costs of entry and exit for global funds have increased significantly. Compared to the tax-friendly regimes found in competing places like Vietnam or Indonesia, India’s regulatory framework no longer has the appeal it once had.
Zero returns in four and a half years: Perhaps the most talked-about figure among global investment banks is this: when measured in US dollar terms, the Nifty index has delivered a compound annual growth rate (CAGR) of almost zero since the end of 2021. For a global fund manager who has held Indian equities for more than four years—and then lost all his capital gains due to currency weakness—proposing a re-entry strategy to his investment committee becomes a very difficult conversation.
Earnings shock: Beyond the current geopolitical crisis, another deep fear is brewing—the fear of a structural decline in Indian corporate earnings. Supply chain disruptions due to the war as well as rising input costs are expected to significantly impact Q1 and Q2 margins of India’s manufacturing and FMCG sectors. FIIs, anticipating this earnings shock, appear to be exiting the market even before the release of official data—a trend that macro data is already indicating. Double-digit earnings growth, which was expected to mark FY27, is now under serious threat. If this geopolitical storm persists, growth could slow to single digits, be postponed for at least two quarters, and perhaps structurally even lower.
