Foreign Funds Pivot: Is the India Growth Story Over?

Introduction: A Tale of Two Markets

A significant shift is underway in global investment flows, as a popular strategy to 'buy India, sell China' appears to be at an inflection point. In recent months, foreign portfolio investors (FPIs) have aggressively sold Indian equities, pulling out nearly $19 billion over a six-month period. This marks the highest outflow recorded in any similar timeframe. The capital is rotating towards Chinese markets, which are perceived as undervalued and are showing signs of recovery, spurred by government stimulus. This large-scale reallocation tests the resilience of the Indian market, which is now heavily supported by a formidable wall of domestic capital.

The Great Rotation: Why FPIs Are Selling India

The exodus of foreign funds from India is driven by a combination of factors, chief among them being stretched valuations. After a record-breaking rally that peaked in September 2024, the Indian market became one of the most expensive in the world. The MSCI India Index was trading at 22 times forward earnings, more than 1.5 standard deviations above its two-decade average. This high valuation made the market susceptible to any negative news.

Compounding the issue is a slowdown in corporate performance. Nifty 50 companies recorded only 5% earnings growth in the December quarter, the third consecutive quarter of single-digit expansion. This follows two years of robust double-digit profit increases, making the recent slowdown more pronounced. Furthermore, signs of weakness in the domestic consumer economy, from tepid rural demand for staples to high inventory levels for automakers, have raised concerns about future growth, prompting analysts to slash earnings forecasts.

China's Renewed Appeal to Global Investors

While investors are trimming their exposure to India, China is regaining favor. The primary catalyst is Beijing's aggressive economic stimulus efforts aimed at stabilizing its economy and reviving growth. Although some analysts question the long-term effectiveness of these measures, they have been enough to spur a recovery in industrial profits and manufacturing activity. The official manufacturing purchasing managers index recently registered its highest reading in a year.

The most compelling draw for investors is valuation. The MSCI China Index trades at approximately 9.1 times its one-year forward earnings, representing a 60% discount to its Indian counterpart. This wide valuation gap, last seen years ago, has historically preceded periods where Chinese equities outperform. Asset managers like Lazard, Manulife, and Candriam have started paring their India exposure to fund investments in China, particularly in themes related to self-sufficiency and the semiconductor supply chain.

The Domestic Wall: India's Unprecedented Resilience

Despite the record foreign outflows, the Indian stock market has avoided a collapse. This stability is credited to the unprecedented strength of domestic institutional investors (DIIs). In 2025, DIIs purchased a record ₹7,20,651 crore in equities, acting as a powerful buffer against FPI selling. This domestic buying power, fueled by record contributions to systematic investment plans (SIPs), has significantly reduced India's traditional dependence on foreign capital.

This divergence in flows has led to a mixed market performance. While the Nifty 50 index has declined 13% since its September 2024 peak, the damage has been contained, especially in large-cap stocks. The sustained domestic support demonstrates a structural shift in the Indian market, where local investors are now a dominant and stabilizing force.

A Mistimed Move? A Contrarian View

Interestingly, the tactical rotation from India to China has not been a straightforward success. According to analysis from CLSA, the move in October 2024 proved to be poorly timed, as both markets subsequently declined by approximately 10% in US dollar terms. The report highlighted that China's anticipated stimulus package was less impactful than expected, functioning more as a debt-management exercise for local governments rather than a significant injection of new capital.

This has led CLSA to reverse its tactical recommendation, returning to a benchmark weighting on China while maintaining a 20% overweight position in India. The firm argues that the $14.2 billion FPI outflow from India since October has created the very buying opportunity that many institutional investors were waiting for.

Market Performance at a Glance

Looking Ahead: Risks and Opportunities

The outlook for both markets remains complex. For India, the primary risk is the persistence of high valuations, which could trigger further outflows if corporate earnings disappoint. However, the country's long-term structural growth story remains intact, and the recent correction may present an attractive entry point for long-term investors, supported by strong domestic liquidity.

For China, opportunities lie in its low valuations and targeted government support for key sectors. However, risks remain, including a persistent property crisis, restrictive monetary conditions, and the looming threat of adverse trade policies, particularly from a potential second Trump administration. The sustainability of its economic recovery is still uncertain.

Conclusion

The narrative of foreign capital shifting from India to China is more nuanced than a simple reversal of fortunes. It reflects a tactical adjustment by global investors weighing India's high-valuation growth against China's low-valuation recovery potential. While FPIs are reallocating funds, the Indian market is demonstrating a new level of maturity, cushioned by a powerful domestic investor base. The coming months will reveal whether this rotation is a short-term tactical play or the beginning of a more durable shift in emerging market leadership.