Indian equities 2026: 5 drivers behind FII selling

India’s underperformance is now hard to ignore

Indian equity markets have started 2026 on a weak note after a prolonged phase of underperformance versus global peers that began in 2025. Despite solid domestic economic fundamentals, returns have been weighed down by persistent foreign investor selling, elevated valuations, and a depreciating rupee. The widening gap has pushed investors to reassess whether the move is a temporary correction or a reset in market pricing. Several reports also point to a shortage of listed, large-cap AI-linked businesses as a factor that has diverted global flows elsewhere. At the same time, domestic flows, especially via mutual funds, have cushioned the market from a sharper fall. But early-2026 data suggests that even this support is showing signs of slowing. The result is a market that is holding up in local terms but looks less attractive in global portfolios.

The performance gap versus global peers

Over the past 12 months, the Nifty 50 delivered a 13.8% return, but that looks modest against some key Asian markets. Korea’s benchmark surged 146% over the same period, while Taiwanese shares rose 70%. Across shorter time frames too, India has trailed most major global and emerging markets, with the MSCI India index posting flat-to-negative returns while markets like Brazil and Taiwan recorded double-digit gains. One report notes that in 2025 India recorded its weakest relative performance against Emerging Markets since 1994, and the trend has carried into 2026. Another data point shows MSCI India gaining 2.5% in 2025 versus 28% for Emerging Markets. In Asian comparisons, Jefferies said the MSCI India Index rose 2.2% in US dollar terms year-to-date in 2025, far behind MSCI AC Asia Pacific ex-Japan at 25.9% and MSCI Emerging Markets at 29.9%. These figures underline that India’s issue is not just absolute returns, but relative attractiveness.

Foreign investors keep selling into 2026

Sustained foreign outflows are a central driver of the underperformance. FPIs pulled a record $19 billion from Indian equities in 2025, and remained net sellers in early 2026, withdrawing another $1.5 billion in the first two months. Separate figures in the broader reporting show annual outflows of $17.9 billion, including $1.7 billion in December alone, underscoring how sharp the late-year selling was. In rupee terms, FIIs offloaded equities worth Rs 1.44 lakh crore in the cash market in 2025. The stated reasons are consistent across accounts: global investors see better profit growth, dividend yields, and valuations in other markets. The reallocation has been more visible as global funds chase markets with clear thematic leadership, particularly those linked to AI and semiconductors.

Valuations remain a hurdle even after muted returns

Even with weaker performance, India’s valuation premium has not fully faded. As of October 2025, Indian equities traded at around 25.2 times trailing earnings, compared with 16.2 times for the MSCI Emerging Markets index. This gap reduces the margin of safety for global investors, especially when other markets offer similar or better growth narratives at lower multiples. Analysts cited in the reporting suggest that unless valuations correct further or earnings growth accelerates significantly, attracting foreign capital will remain difficult. The market’s multiples have been held up, with some commentary warning that a structural decline in multiples could bring valuations closer to business fundamentals rather than historical highs. One report also argues that price-insensitive retail buying has delayed this adjustment. Separately, the earnings cycle has been described as slowing, with Jefferies estimating MSCI India earnings growth at about 10% in FY26 ending March 31, 2026.

Rupee weakness hits dollar returns directly

Currency has been a persistent drag for international investors. The rupee has slid to record lows and breached the 90-per-dollar mark, with another reference noting the exchange rate crossing 90.4 to a new low. Jefferies also cited a 5.3% depreciation of the rupee against the US dollar so far in 2025, with the currency breaking the 90 level in December. For overseas investors, this matters because even positive local index returns can be diluted when converted back into dollars. Reporting notes that rupee weakness in 2025 nearly wiped out the Nifty 50’s headline gains in dollar terms for a global investor. The currency risk has been linked to concerns over external trade and high crude oil prices, and also to uncertainty around a stalled India-US trade deal and tariff differences.

Missing the global AI rally

A key reason India has lagged in global asset allocation is the AI-led rally elsewhere. US, Taiwan, and Korea markets have benefited from investor enthusiasm for AI-related companies and the semiconductor ecosystem. India, by contrast, is described as lacking a significant number of large, listed companies that offer a direct play on the AI theme. This has meant that capital seeking high-growth exposure has often bypassed India. Several narratives in the reporting frame this as part of the reason India was priced as a premium market for years, but that premium gets questioned when growth looks less clean and global themes shift.

Domestic flows cushion the fall, but momentum is watched

Domestic investor participation has been the main stabiliser during heavy foreign selling. Reports highlight steady mutual fund inflows that absorbed a significant portion of FPI selling, limiting the downside. Another set of figures shows domestic institutional investors infused over Rs 7 lakh crore into equities during 2025, cushioning the impact of FII outflows. However, early 2026 commentary suggests the momentum of domestic flows has shown signs of slowing. That makes retail and domestic institutional behaviour a key variable for near-term market direction. The market’s path will depend on whether domestic demand can stay consistent even if global funds remain cautious.

Key numbers at a glance

Market impact: what these factors change for investors

In the near term, the combination of high valuations, foreign selling, and currency weakness keeps India sensitive to global risk appetite. A weaker rupee can reduce the appeal of Indian equities for dollar-based investors, even when local indices are positive. Persistent FPI selling can also pressure liquidity in specific sectors and stocks that are heavily owned by overseas funds. Meanwhile, the lack of large AI and semiconductor plays has consequences for index-level positioning, because global thematic funds often allocate by sector exposure rather than country narrative alone. Domestic inflows have reduced volatility, but if that support slows, price discovery may become more dependent on earnings delivery and valuation comfort. Reporting also flags that uncertainty around the India-US trade deal and tariff policy has added to caution and may influence exports and the trade deficit.

Analysis: cyclical correction or a valuation reset

The data points in the reporting consistently point to three issues: valuation premium, earnings deceleration, and currency drag. When these occur together, markets can face a period of derating even without a major domestic shock. The argument about a potential structural decline in multiples is tied to sector disruption and limited corporate investment to address threats, with retail buying delaying the adjustment. At the same time, the cyclical view is supported by the fact that global capital has rotated hard toward AI and semiconductor beneficiaries, which India does not represent well at scale. In practice, both can be true: global thematic rotation can trigger outflows, and a high starting valuation can magnify the relative underperformance. What follows depends on whether earnings growth improves and whether the rupee stabilises, both of which are highlighted as key watchpoints.

What to watch through 2026

Several forward markers are already on investors’ dashboards. Market narratives repeatedly mention the need for either faster earnings growth or a valuation correction to bring foreign flows back. Currency stability also matters, given the direct hit to dollar returns when the rupee weakens past 90. Policy and geopolitics remain in focus, including the status of the India-US trade deal and the broader impact of global risk events on emerging market allocations. Investors are also monitoring whether domestic mutual fund inflows remain strong enough to absorb any renewed foreign selling.

Conclusion

India’s early-2026 underperformance is being driven by measurable factors: persistent FPI outflows, elevated valuations versus peers, and rupee depreciation that reduces dollar returns, alongside weaker AI-linked market exposure. Domestic inflows have provided a cushion, but the pace of those flows is being closely watched. The next phase for Indian equities will likely depend on confirmed improvements in earnings momentum, any easing in currency pressure, and clearer signals on policy uncertainty such as the pending India-US trade deal.