Foreign investors may reverse their stance on Indian markets. A rally in Sensex and Nifty is expected. US Federal Reserve rate cuts and India's economic resilience are key factors. GST reductions and other reforms are also important. Earnings recovery is expected from Q3FY26. This could trigger renewed capital inflows. The macroeconomic foundation of India remains strong.
After offloading a massive Rs 1.4 lakh crore from Indian markets in 2025, foreign institutional investors (FIIs) may finally be at the crossroads of their biggest reversal bet yet. With the US Fed cutting rates, India Inc earnings recovery on the horizon, and the Modi government rolling out growth-friendly reforms like GST cuts, the stage is being set for FIIs to make their comeback -- just as Dalal Street brews its next big rally.
After cutting interest rate by 25 basis points, the US Fed has signalled two additional rate cuts in 2025.
"Historically, when the Fed lowers rates, capital tends to shift out of safe assets such as U.S. Treasuries and bank deposits into riskier assets, including equities, private equity, venture capital, and emerging markets. As a result, India should expect stronger capital inflows -- particularly in Q4, when large global asset managers finalize allocations," explained Artha Bharat's Nachiketa Sawrikar, who manages the $100 million long/short fund from Boston.
The implications are clear: a weaker U.S. dollar will drive capital inflows through carry trades and foreign direct investment, directly boosting India's stock market.
"The Federal Reserve rate cut will make emerging markets like India more attractive for yield-seeking investors, potentially triggering renewed capital inflows," said Dhiraj Relli, MD & CEO of HDFC Securities.
What makes this moment particularly compelling is the convergence of global monetary easing with India's demonstrated economic resilience. Despite facing headwinds including the Trump administration's imposition of a 50% tariff on Indian exports, the Indian economy continues to show remarkable strength.
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Rajesh Palviya, SVP - Research at Axis Securities, believes the stars are aligning: "In India, the Fed's actions could attract foreign capital, strengthening the rupee and benefiting stock indices like the BSE Sensex and NSE Nifty. When combined with domestic factors, including the RBI's earlier interest rate reductions, specifically a 50 basis point cut in June 2025 and another cut in April, as well as GST rate rationalization and various measures to boost consumption, the outlook for India's economy appears strong."
The projection is robust: "Potential GDP growth is projected to remain steady at around 6.5% to 6.7% for FY2025/26," Palviya noted, identifying banking, financial services, and insurance (BFSI), information technology (IT), metals, and domestic consumption sectors as positioned for potential gains.
The massive foreign outflow wasn't without reason. Market experts point to a confluence of factors that spooked international investors.
"Foreign institutional investors (FIIs) continue to show cautious behavior towards Indian markets, primarily due to a prolonged period of muted corporate earnings growth over the last four consecutive quarters," explained Shrikant Chouhan, Head Equity Research at Kotak Securities.
The valuation argument was equally compelling. "At present, Indian equities are trading at around 19 times one-year forward earnings and 22 times trailing twelve-month (TTM) earnings. When we benchmark these valuations against other key emerging markets, such as China, Indonesia, Thailand, and Korea, we find that these markets are still trading at considerably cheaper valuations, often below 13 times forward earnings," Chouhan added.
Sunny Agrawal, Head of Fundamental Research at SBI Securities, identified three key factors behind the underperformance: "Domestic indices have underperformed most of the global indices due to (a) deceleration in earnings growth beginning Sept-24 qtr coupled with relatively expensive valuations. FY26 is likely to deliver single digit earnings growth with likely recovery to 12-14% during FY27. (b) Populist measures adopted during the beginning of 3rd term by the government and pursuant slowdown in government capex also deteriorated market sentiments. (c) global uncertainties led to flight of capital to safe haven."
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Despite the recent exodus, several factors are aligning to potentially reverse FII sentiment in the coming quarters.
The single biggest catalyst for FII return will be earnings recovery. While Q1 earnings have been moderate, a stronger performance in Q2 would signal a pick-up in economic activity and corporate health, reassuring investors and driving stock-specific rallies.
While the US Fed is expected to deliver another 50 bps cut in the next three months, the RBI too is widely tipped to slash rates by another 50 bps this year, taking the total easing in 2025 to 150 bps. Together with fiscal boosters such as GST and income-tax cuts, the RBI's rate cycle is set to release liquidity and stimulate economic activity.
The third trigger could be a mutually agreeable resolution to ongoing trade negotiations with the US would eliminate policy uncertainty and restore FII confidence in Indian markets.
Axis Securities' Neeraj Chadawar, said the focus of the market remains on the domestic recovery, as the prospects of earnings recovery in the domestic market starting from Q3FY26 onwards have significantly improved after the announcement of GST rationalization.
"FIIs are global investors; they always look for investments in countries and generally adopt an overweight and underweight stance based on each country's future outlook. In the last 12 months, with some slowdown in earnings momentum in the domestic market, FIIs have been reallocating some investments to other countries. This doesn't mean that they are not believers in India's growth story; rather, it is a natural process," Chadawar explained.
The recovery timeline is becoming clearer: "Starting from Q3FY26, the transmission of fiscal and monetary benefits and reforms announced in the last 6-12 months are likely to be visible in corporate earnings. With this positive trigger, FIIs are likely to return to the domestic market in the second half of the current fiscal year."
What makes this potential reversal particularly powerful is what Sawrikar calls the "double engine" effect: "India stands to benefit from a 'double engine' of global liquidity easing and strong domestic fundamentals."
The macroeconomic foundation remains solid. As Chouhan notes: "Despite these headwinds, India's macroeconomic fundamentals remain strong: GDP growth is holding steady above 7.5%, signaling continued economic expansion. Inflation is contained at around 2%, well within the comfort zone of policymakers."
So are FIIs done betting against India? The evidence suggests a potential inflection point. Current consolidation presents what many see as excellent buying opportunities within the broader uptrend, allowing investors to accumulate quality stocks before the next leg of the rally.
"If the two upcoming events - 1) tariff negotiations aligning with market expectations without further deviations, and 2) the transmission of fiscal and monetary benefits translating into stronger economic momentum and earnings growth for Indian corporates from Q3 FY26 onwards - play out as anticipated, the market is likely to scale to a new high in the upcoming quarters," Chadawar concluded.
India's structural growth story remains intact as one of the world's fastest-growing economies, supported by strong demographics, rising middle-class consumption, a thriving start-up ecosystem, and ongoing reforms. With H2FY26 expected to drive earnings recovery, improved corporate performance could lead to higher stock prices.
The ₹1.4 lakh crore question may soon have its answer: FIIs appear poised to correct their massive bet against Indian markets, potentially triggering the next major rally in Sensex and Nifty. The only question that remains is not if, but when the floodgates will open.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of the Economic Times)