India Sees Major Foreign Equity Outflows as Tax Hike, EM Rivals Draw Capital

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AuthorAarav Shah|Published at:
India Sees Major Foreign Equity Outflows as Tax Hike, EM Rivals Draw Capital
Overview

Foreign investors are selling Indian stocks for the second year in a row, offloading an estimated ₹1.76 trillion in FY26, up from ₹1.27 trillion in FY25. This is driven by new domestic tax rules and stronger growth prospects in other Asian markets. While Indian institutional investors are buying heavily, there are worries about this support lasting amid global economic shifts and geopolitical issues. Analysts expect foreign selling to continue into early FY27 before potentially reversing later in the year.

Foreign investors are significantly reducing their holdings in Indian stocks. This shift reflects changing views on risk, driven by adjustments to India's investment appeal and attractive growth opportunities in other Asian markets. These outflows pose a major challenge, questioning the market's ability to maintain its momentum using only domestic funds, especially with global economic conditions remaining unstable.

Foreign portfolio investors (FPIs) sold Indian equities worth roughly ₹1.76 trillion in fiscal year 2025-26 (FY26), a jump from ₹1.27 trillion in FY25. Foreign Institutional Investors (FIIs) alone divested Indian stocks worth ₹3.15 trillion during FY26. A primary driver of this sell-off is India's revised long-term capital gains (LTCG) tax policy. Starting April 1, 2026, the tax on LTCG will be 12.5% without indexation benefits. This makes India's after-tax returns less attractive for foreign investors, particularly those who cannot claim double taxation relief at home. Market expert Samir Arora called this tax change a "big mistake" that could harm India's investment image. In comparison, markets like Taiwan and South Korea reportedly charge no capital gains tax on equities for foreign investors, making them more appealing. These rival Asian markets are seeing significant foreign investment, boosted by AI trends and strong tech exports, drawing about $25.7 billion in the three months ending July 2025. India, meanwhile, experienced outflows exceeding $2 billion in July 2025, its largest monthly divestment in the region that year.

Meanwhile, domestic institutional investors (DIIs) have stepped in as strong buyers, purchasing Indian equities worth an estimated ₹8.31 trillion. DII equity inflows hit a record $90.1 billion in calendar year 2025 (CY25), up from $62.9 billion in CY24. DIIs now hold a record share of Indian stocks, surpassing foreign ownership by mid-2025, which provides market stability. Regular inflows from systematic investment plans (SIPs), about ₹30,000 crore monthly, and contributions from insurers and the EPFO are expected to maintain this buying support. Mutual funds, with around $6 billion in available cash, could see total DII inflows exceed $100 billion in FY27.

India's stock market is also trading at a higher valuation than other emerging markets. The Nifty P/E ratio was 20.690 on March 26, 2026, compared to the MSCI Emerging Markets Index P/E of 16.98 (as of Jan 1, 2026). This premium, along with slower expected earnings growth, can make foreign investors hesitant. Global economic challenges add to the concern. Ongoing geopolitical tensions in West Asia have pushed crude oil prices towards $108 per barrel, straining India's import-reliant economy. Each $10 rise in oil prices could widen India's current account deficit by 0.4-0.5% of GDP and reduce GDP growth by 0.5%. This impact, combined with a weaker rupee, fuels inflation and increases government subsidy costs.

The combination of the new tax rules and competition from rival markets creates a significant hurdle for attracting foreign capital to India. While domestic investors provide strong support, their ability to continually absorb large foreign sell-offs is being closely watched. Any faltering domestic inflows or a sharp shift in global sentiment could lead to considerable market pressure, especially given India's relatively high valuations.

However, analysts see potential for foreign investor sentiment to improve in the latter half of FY27. This outlook depends on a stable Indian Rupee, faster corporate earnings growth (projected at 12-14% for FY27), and reduced global geopolitical tensions that might lead the US Federal Reserve to lower interest rates, encouraging emerging market investments. A new US-India trade deal could also reduce uncertainty and boost confidence. Major firms like Goldman Sachs remain optimistic, forecasting 16% profit growth for India in FY27. S&P Global Ratings has raised India's GDP growth forecast for FY27 to 7.1%, suggesting a positive long-term fundamental view that could eventually attract foreign capital, provided these policy and economic concerns are managed well.

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