Indian markets are staying afloat thanks to strong local credit growth, even as foreign investors pull out billions from equities. While bank lending to companies and consumers is surging, the massive foreign institutional investor outflows and rising global oil prices remain significant hurdles for investors to monitor.
Indian equity markets are currently caught in a tug-of-war. On one side, domestic economic activity is showing resilience through robust credit expansion, which provides a buffer for the markets. On the other side, persistent selling by foreign institutional investors (FIIs) has created a significant hurdle, testing the market's strength throughout the year.
The Domestic Credit Engine
A key pillar of the current market resilience is the surge in bank lending. Recent data shows that bank credit growth has hit 17-18% year-on-year, a level not seen in over a decade. This is not just broad-based; it is led by corporate lending, which has expanded by roughly 20%. When companies take loans, it is often a sign of planned expansion or project execution, and when this is paired with healthy growth in retail and agricultural lending—16% and 17% respectively—it indicates that domestic consumption and investment demand remain intact.
Capital Flows and Currency Stability
To balance the impact of heavy foreign equity selling, which has reached approximately $25.4 billion year-to-date, the authorities have moved to stabilize the rupee and attract capital through other channels. The Reserve Bank of India (RBI) launched a concessional deposit swap scheme for non-residents, which has successfully drawn in about $41 billion. There are expectations that this could climb to $80-100 billion before it concludes in September 2026.
Additionally, the government has taken steps to encourage foreign investment into the debt market by removing withholding and capital gains taxes on interest income from government securities. This has yielded results, with $8.7 billion flowing into government bonds since June. These debt inflows have been crucial in providing the foreign currency support needed to stabilize the rupee, preventing the type of sharp currency depreciation that often scares off equity investors.
Risks and Market Headwinds
While the domestic narrative is one of strength, investors must remain aware of several clear risks. The most immediate concern is the sustained exit of FIIs from the equity market. If this trend continues without a corresponding rise in domestic institutional buying, it could limit market upside.
Furthermore, the banking sector faces a liquidity challenge known as the credit-deposit gap. With credit growing at nearly 20% in the corporate sector, banks are seeing their liquidity stretched as deposit growth struggles to keep pace, currently resulting in a gap of 570 basis points. If banks cannot mobilize deposits faster, their ability to continue this high pace of lending could be constrained. Finally, global factors such as rising crude oil prices—now trading above $80 per barrel—and ongoing geopolitical tensions continue to pose threats to inflation and the import bill, which can quickly turn sentiment negative.
Investors should track the upcoming monthly data on credit growth and deposit mobilization, as any sign that banks are slowing down their lending could impact corporate earnings forecasts. Additionally, the trend in FII equity flows compared to the pace of domestic debt inflows will be a key indicator of market stability in the coming months.