Indian markets may continue to experience subdued foreign portfolio investor (FPI) inflows, according to a recent report by Kotak Institutional Equities. The financial firm highlights India's growing external capital dependency as a critical factor influencing this trend, a vulnerability that has become more apparent over the last two years.
Rising External Capital Dependency
Kotak's analysis indicates that a notable slowdown in net Foreign Direct Investment (FDI) flows, coupled with an increase in FPI outflows, has coincided with a higher current account deficit (CAD). This deficit has been largely driven by elevated global energy prices. Historically, substantial capital inflows had offset India's structural trade and current account deficits until FY2024. However, Kotak suggests this vulnerability could persist without structural reforms to address the high CAD.
The report emphasizes that reduced capital inflows and a weaker current account position have diminished the capital account buffers available to absorb India’s persistent structural trade deficits. Furthermore, Kotak cautions that India’s CAD could weaken further in FY27 if crude oil prices remain high, potentially adding pressure on the overall balance of payments.
Weak Net FDI Flows and Outward Investments
The observed weakness in net FDI flows stems from a steady rise in gross FDI outflows by both foreign and Indian entities, increasing from $15 billion in FY21 to $28 billion in the first nine months of FY26. Indian companies are expected to continue pursuing outward investments, driven by geographical expansion strategies and the need for technology acquisition.
While gross FDI inflows from overseas entities have largely held up, their impact has been nullified by significant outflows. These include exits by private equity (PE) and venture capital (VC) investors from their Indian holdings, as well as multinational corporations conducting offer-for-sale (OFS) transactions for their Indian subsidiaries in primary and secondary markets. Kotak anticipates that gross FDI outflows by foreign entities will remain elevated, given the substantial stakes PE and VC investors still hold in both listed and unlisted Indian companies.
India's Relative Attractiveness Wanes
Kotak also points out that FPI inflows may remain muted because India appears less attractive compared to other emerging markets on several fronts. These include:
- Weaker relative earnings growth projections for FY2027E, both in terms of quality and quantity.
- Negative exposure to the ongoing artificial intelligence (AI) and semiconductor cycles, which are expected to continue for another one to three years.
- Negative exposure to key commodities, particularly crude oil and natural gas.
In contrast, other emerging markets offer greater exposure to these crucial AI and commodity cycles. Kotak notes that sustained large FPI outflows from Indian equities reflect a steady deterioration in relative returns and a continued compression in relative earnings growth expectations.
Overall, Kotak concludes that India is grappling with a combination of slower net FDI, elevated gross FDI outflows, ongoing PE and VC exits, muted FPI flows, and pressure from high oil-linked current account deficits. This complex mix is likely to keep foreign portfolio inflows subdued in the near term.