Why Foreign Investors Still Matter to Indian Markets, Despite Declining Influence

Foreign investors hold 17% of Indian equities but their influence has declined due to reduced global allocations to emerging markets (EMs). India now captures around 20% of EM inflows but still faces outflows despite its outperformance. Asset managers dominate foreign ownership, with $200 billion in India-dedicated investments. As India's market weight rises, attracting capital will depend on governance, ease of business, and local factors, offering long-term growth potential for investors.

Foreign investors continue to play a significant role in the Indian equity markets, holding approximately 17% of its broader market capitalization. However, their influence on stock price movements has waned compared to a decade ago. This shift reflects changing global investment dynamics and India's evolving position within emerging markets (EMs).

In recent discussions, several factors have been identified as reasons for reduced foreign investments in India. These include profit-taking due to India’s outperformance relative to other markets, concerns over slower economic and earnings growth, India's perceived over-valuation, and a broader slowdown in net inflows into emerging markets. This article delves into the last point — the deceleration in foreign portfolio investments in EM equities over the years.

The Global Picture: Shrinking Allocations to Emerging Markets

Global investors allocate their capital across asset classes such as fixed income, equities, and alternatives, and by regions. Typically, a significant portion of their investments is directed toward their home country and other developed markets. Emerging markets, including India, represent only a small slice of the overall investment pie.

According to a report by the Bank for International Settlements (BIS), annual foreign portfolio inflows into emerging market equities have fallen dramatically over the past decade. These flows, which averaged more than $100 billion annually, now hover around $50 billion.

Since 2007, cumulative foreign portfolio flows into EM equities totaled $1.38 trillion. Of this, India accounted for $168 billion—approximately 12% of the total. India has experienced years like 2020 when it received over half of all EM flows, and other years when it faced outflows even as EMs collectively attracted net inflows.

India’s growing weight in the MSCI Emerging Market Index, rising from 7% to 20%, has helped it capture a larger share of EM flows. On average, India now garners around 20% of EM equity inflows.

Why India’s Outperformance Isn’t Enough

India’s share of global inflows is heavily influenced by overall allocations to EM equities. If annual portfolio flows into EM equities were $150 billion, India would theoretically receive $30 billion. However, the only year India achieved such inflows was in 2010.

Despite its relative outperformance, India has not attracted as much capital as expected. In fact, India's strong performance has sometimes triggered outflows, as investors reallocated funds to other markets. This paradox arises because the total pool of EM investments has not expanded significantly.

Emerging markets, as a group, have underperformed developed markets in recent years. Consequently, global investors have reduced their allocations to EM equities, which has indirectly constrained flows to India. However, this cautious approach has also meant that global investors remain underweight in India, potentially missing out on the country's ongoing growth story, which is reflected in the robust performance of Indian public equities.

Foreign Ownership in India: A Closer Look

Foreign ownership of Indian equities is dominated by asset managers and funds, which account for 70% of the total holdings, according to data from NSDL and Quantum Advisors. Offshore India-dedicated funds manage approximately $130 billion in assets, representing about 22% of foreign investments by asset managers. The remainder comes from funds with broader mandates, such as global, EM, or Asia-focused funds.

The second-largest category of foreign investors includes central banks, sovereign wealth funds (SWFs), and government entities, which collectively own $137.8 billion in Indian equities, or 16% of total foreign holdings. A similar proportion of these investments—roughly 20%—is estimated to be India-dedicated.

Overall, India-dedicated investments, whether through funds, direct investments, or specialized mandates, are estimated to total around $200 billion, accounting for 23% of total foreign ownership. The rest is allocated through broader regional or global mandates.

India’s Growing Appeal

India’s dedicated share of foreign investments is expected to rise as its contribution to global GDP and market capitalization continues to grow. However, to attract more capital, India must address several factors, including its governance, rule of law, ease of doing business, and tax policies.

As India becomes increasingly significant to global investors, its equity flows will depend more on domestic factors than on broader EM trends. This shift could help insulate India from the cyclical declines in EM inflows and position it as a more stable and attractive destination for global capital.

While foreign investors may no longer dictate the direction of Indian markets as they once did, their participation remains a critical component of India's financial ecosystem. As India strengthens its global economic standing, the potential for increased foreign investment remains promising.