FIIs will return to India, but these 5 reasons will keep them at bay for some time

Foreign institutional investor (FII) selling has remained the biggest drag on Indian equities since 2024 and while recent inflows have offered some relief, domestic brokerage Elara Securities believes a broad-based return of overseas capital is still some distance away.

The brokerage said that foreign investors have been persistent sellers since the Middle East conflict began, with 82% of trading sessions witnessing net outflows from Indian equities, amounting to $32 billion.

The selling eased only after mid-June, when improving geopolitical developments, the Reserve Bank of India's measures to curb one-way depreciation in the rupee and a sharp decline in commodity prices, particularly crude oil, helped attract nearly $3billion of net inflows. Even so, Elara pointed out that these inflows remain modest compared with the $29.3 billion that exited Indian equities between the beginning of March 2026 and June 15, 2026.


Also read: Dual engines to fuel bull market? Mutual fund cash hits multi-year low of 4% as FIIs turn buyers after 4 months

Here are 5 reasons why FIIs may keep their distance from Dalal Street:

1.) Valuations more attractive, but India lacks a strong trigger

According to Elara, India's valuation premium over emerging markets has corrected sharply, with the MSCI India-to-MSCI Emerging Markets price-to-earnings multiple falling to 1.30x from 1.73x in June 2025. However, the brokerage believes attractive valuations alone are unlikely to drive a sustained revival in FII flows.

It expects foreign investors may selectively increase exposure to India as a contrarian trade, but a broader return of capital will require two key developments: a cooling of the ongoing U.S. artificial intelligence-led rally and a meaningful improvement in corporate earnings. Until then, India lacks an immediate thematic trigger that can attract large foreign allocations beyond selective buying opportunities.

2.) Global risk-off periods typically favour U.S. Treasuries

Elara also drew parallels with previous financial market dislocations, arguing that history suggests global investors usually move money into U.S. government bonds immediately after the bursting of a financial bubble.

The brokerage cited the 2007-09 financial crisis as an example, when net purchases of U.S. government debt remained elevated at between $100 billion and $150 billion even as global equity markets weakened sharply. Equity flows across both developed and emerging markets turned deeply negative through late 2008 and early 2009, bottoming near negative $90 billion following the collapse of Lehman Brothers. According to Elara, this divergence shows that global institutional investors typically prioritise capital preservation by moving into Treasuries before eventually returning to equities, a process that generally takes three to four quarters.

3.) India's relative appeal has weakened

The brokerage also believes India's relative value proposition has become less compelling from the perspective of foreign investors.

It noted that the U.S. Federal Reserve's increasingly hawkish stance has strengthened the U.S. dollar and pushed Treasury yields higher. The real U.S. yield has remained on an upward trend throughout the year, while the 10-year Treasury yield has hovered around 4.5%. As a result, the yield spread between Indian and U.S. 10-year government bonds has narrowed to about 220 basis points.

Read more: A $2.5 billion FII buying has domestic investors asking: Is foreign money shifting to India?

After adjusting Indian equity valuations for the cost of hedging the rupee through the three-month annualised forward premium, Elara estimates the implied risk premium turns negative at 3.03%, reducing the attractiveness of Indian equities for fully hedged foreign investors.

4.) Global capital is moving back towards U.S. assets

Another factor limiting flows into India is the ongoing shift in global capital towards U.S. assets.

Elara said markets are increasingly favouring a "dollar asset trade", supported by a stronger U.S. dollar, firmer Treasury yields and investor preference for U.S.-denominated assets.

The trend has strengthened further following the recent hawkish comments from Federal Reserve Chair Kevin Warsh. Market expectations have shifted from anticipating interest rate cuts to pricing in the possibility of a rate hike, reinforcing flows into both U.S. equities and debt markets.

5.) Technology flows remain concentrated in the U.S.

Sectoral fund flow trends also continue to favour the United States over other markets. Based on EPFR data, Elara noted that infrastructure funds attracted $30 billion during the second quarter of CY26, up from $19.5 billion in the previous quarter.

Technology continues to receive the largest share of global equity flows, although the pace has moderated. Net inflows into global technology funds declined to $81.7 billion in Q2CY26 from $99.6 billion in Q1 and $191.5 billion in Q4CY25.

Importantly, these flows are becoming increasingly concentrated in the United States. U.S. technology funds attracted $16.9 billion in June 2026 on a four-week rolling basis, up from $7.2 billion in May. In contrast, technology funds outside the U.S. recorded outflows of $4.4 billion in June, compared with $2.4 billion in May, led by withdrawals from China and South Korea.

Taken together, Elara believes these global trends suggest that while India may continue to see selective foreign buying, a meaningful return of FII flows is likely to take longer as global investors continue to favour U.S. assets and wait for stronger earnings and a more compelling investment theme in India.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)