Foreign institutional investors (FIIs) have pulled almost $40 billion from Indian equities over the past two years, according to a note from research house Bernstein. While the outflows have been substantial, the brokerage’s analysts argue that the next 12 months could see FII activity stabilise at a flat‑to‑modestly‑positive level, but primarily as short‑term traders rather than long‑term investors.
Why the case for a structural India allocation has weakened
Bernstein’s managing director Venugopal Garre, together with analyst Nikhil Arela, wrote that the traditional appeal of Indian large‑cap stocks has eroded. They note that many of these companies are “struggling to reinvent themselves,” with incumbent business models under pressure from new technologies. The analysts added that small‑ and mid‑cap firms, often referred to as SMIDs, are “difficult to access at institutional scale,” making it harder for foreign capital to justify a durable allocation to the market.
The note points to the performance of the Nifty index as a further deterrent. Over the last decade, the index has delivered roughly a 6 percent annualised return when measured in U.S. dollars. By contrast, the past two years have seen an 11 percent annualised decline. Garre and Arela argue that such a track record diminishes the perception of India as a “bright spot” for foreign investors.
Cyclical patterns in institutional flows
Bernstein highlights a recurring cycle in the flow of capital from both domestic and foreign institutional investors. Typically, two to three years of foreign inflows are followed by a lull period during which domestic institutional investors (DIIs) peak and FIIs either lock in profits or hold cash. Historically, the peak of FII inflows has hovered around $25 billion per year, while DII inflows have peaked at a lower $15‑20 billion annually.
The analysts note that simultaneous strong buying from both FIIs and DIIs has been rare, with 2023 cited as the most recent instance of both groups acting as significant buyers. This cyclical behaviour, they suggest, underpins the modest outlook for future foreign inflows.
Large‑caps, SMIDs and the challenge of capital deployment
According to the Bernstein note, India’s large‑cap firms represent a “bygone economic era.” The commentary observes that many of these companies are focused on consolidating past gains rather than investing in future growth, often relying on policy support to shield themselves from global competition.
The report also links India’s limited progress in emerging sectors—such as electric vehicles, semiconductors and solar energy—to a reluctance among deep‑pocketed firms to commit capital. If large‑caps cannot deliver the growth needed to attract FIIs, the analysts say foreign investors would have to look toward SMIDs. However, most SMIDs suffer from low free‑float percentages, limited liquidity and sparse analyst coverage, conditions that are “hardly an ideal destination for large institutional capital.”
Garre and Arela warn that flows into SMIDs are often driven by news headlines rather than solid fundamentals. The market, they explain, rewards positive narratives but can punish sharply when quarterly results fall short. By the time a handful of SMID winners become truly investible, much of the early value creation may already have occurred.
The limited impact of AI‑driven trading
Bernstein also comments on the broader context of artificial‑intelligence‑driven trading across global markets. The analysts contend that even if AI‑related trading peaks, it is unlikely to revive FII flows into India. Global capital, they argue, is not designed to chase “annuity‑like” returns while accepting the valuation, liquidity and execution risks that increasingly characterize parts of the Indian market.
For a genuine structural revival in foreign inflows, the note stresses that India must develop globally competitive industries in emerging areas. Specific capabilities highlighted include advanced semiconductor manufacturing (beyond mere assembly), deep expertise in batteries and energy storage, greater energy self‑sufficiency, and business models capable of securing meaningful market share on the world stage.
In summary, while Bernstein anticipates that FII activity could level out over the coming year, the firm sees little evidence of a long‑term, structural shift in foreign capital allocation to India. The combination of large‑cap stagnation, SMID liquidity constraints and the broader risk‑averse posture of global investors suggests that any return of FIIs may be limited to short‑term trading rather than sustained investment.
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