Foreign institutional investors (FIIs) have been aggressively selling Indian stocks, triggering concerns across the market. The sustained FII outflows are not limited to the IT sector alone but are affecting a broad range of stocks, leading to significant losses in retail investor portfolios. The current market downturn can largely be attributed to capital outflows towards the US markets, where a strengthening dollar and attractive US bond yields are drawing investors away from emerging markets like India.
Several factors have contributed to the underperformance of domestic markets, including weak Q3 earnings and the overvaluation of smallcap and midcap stocks. Analysts have pointed out that earnings and valuations have been out of sync for the past two quarters, leading to corrections in segments that previously enjoyed high investor interest. As a result, smallcap and midcap stocks are experiencing sharp declines, with funds flowing towards the relative safety of largecap stocks.
A major trend reversal is taking place, as last year’s strong inflows into small and midcap equity mutual funds are now shifting towards largecap funds. This change in investment strategy is driving the severe underperformance of small and midcap stocks. Market analysts believe this underperformance is likely to persist in the near term, with investors prioritizing stability over high-risk opportunities.
Adding to the challenges, China’s economic recovery efforts are posing a fresh concern for Indian markets. The Chinese government has been actively encouraging its top businessmen to invest, creating a potential draw for FIIs. With Chinese stocks trading at lower valuations—such as the Hang Seng Index at a price-to-earnings (PE) ratio of 12.6—global investors may find the Chinese market more attractive, leading to continued outflows from Indian equities.
For stock market investors, experts advise against panic-selling and emphasize the need to reassess portfolio strategies. A prolonged FII selloff could lead to heightened volatility, a decline in stock prices, and a depreciation of the Indian rupee. Sectors with high FII exposure, such as IT and banking, are expected to bear the brunt of this selling pressure.
At the same time, market downturns present an opportunity for investors to build quality portfolios at reasonable or attractive valuations. Analysts suggest that largecap stocks should be the preferred choice during this period, as mid and smallcap stocks may continue to witness fund outflows.
Despite the current headwinds, FIIs are expected to return to India once global conditions shift in favor of emerging markets. Key factors that could bring FIIs back include anticipated interest rate cuts, strong economic growth, favorable stock valuations, and political stability in India. Additionally, the country’s robust domestic demand and corporate earnings growth make it an attractive long-term investment destination.
A major trigger for FII buying could be the depreciation of the US dollar and a decline in US bond yields, though this may take some time. A strong indicator that could turn FIIs into buyers would be a clear signal of earnings recovery in India, which is expected by early FY 2026. Market watchers will be closely monitoring high-frequency economic indicators for signs of a turnaround in growth and earnings in the coming months.
