Foreign Investors Shun India: Rupee Tumbles

Foreign investors have reduced their exposure to Indian equities and shown caution towards the domestic debt market. This trend is influenced by India's premium valuation, subdued corporate earnings growth projected for 2025-26, and the lack of AI-driven growth. A significant, yet less discussed, factor is the rise in global bond yields, diminishing the relative attractiveness of Indian assets.

The rupee has experienced a sharp depreciation, falling by ₹10 against the US dollar in the past year to reach 94. This weakening is partly attributed to foreign investor caution. US and European corporate bond yields above 5% and 4% respectively, coupled with stronger currencies, present a more favorable risk-adjusted return compared to India's volatile INR corporate yield of around 7.75%.

Globally, developed economies' financial markets have outperformed emerging markets amidst inflationary pressures and geopolitical risks. The hawkish stance of global central banks and rising interest rates have made India's bond market less appealing for foreign investors seeking superior returns. While accommodative domestic interest rates support local borrowing, they reduce India's appeal to foreign capital.

A notable impact has come from the reversal of yen carry trades due to rising bond yields in Japan. Japanese investors, who previously deployed significant capital into emerging markets, have reversed this trend. Over the past 12 months, Foreign Institutional Investors (FIIs) invested over US$100 billion in Japan while selling approximately US$38 billion in India. Japanese holdings in India have declined by about 12% over the past year, a pattern mirrored by investors from the US, Singapore, and Mauritius.

The persistence of a hawkish US Federal Reserve policy may prolong unfavorable conditions for Indian markets. However, India's expected inclusion in the Bloomberg Global Aggregate Index could attract incremental debt inflows. A decrease in crude oil prices to $70, reduced geopolitical risks, and sustained healthy real returns would be crucial for boosting both debt and equity inflows from foreign investors.