Indian Equities Lag Global Peers in 2025 Amid Record Outflows

A Year of Divergence for Indian Markets

While global equity markets experienced one of their strongest years in 2025, Indian stocks charted a starkly different course. The market witnessed its most significant underperformance against Asian and emerging market peers in nearly three decades. This divergence was driven by a combination of high valuations, record foreign capital outflows, a weakening rupee, and unexpected trade headwinds, creating a challenging environment for investors despite India's economy growing at a solid 6%.

The Scale of Underperformance

The performance gap between India and other major markets in 2025 was substantial. The MSCI India Index managed a modest gain of only 2.2% in U.S. dollar terms. This pales in comparison to the broader rallies seen elsewhere. The MSCI Emerging Markets index climbed 29.9%, while the MSCI AC Asia Pacific ex-Japan index surged by 25.9%. Other markets like South Korea and Mexico posted even more dramatic year-on-year gains of 60% and 62.29%, respectively, highlighting the extent to which foreign investors favored other destinations over India.

Record Foreign Capital Flight

A primary driver of India's underperformance was the unprecedented withdrawal of funds by foreign institutional investors (FIIs). In 2025, foreign funds pulled a record $17.9 billion from Indian equities, with $1.7 billion withdrawn in December alone. This capital flight was fueled by several factors. Persistently high valuations made Indian stocks appear expensive compared to peers in North Asia and Latin America. As cheaper opportunities with clearer AI-linked growth stories emerged in markets like Taiwan and South Korea, global fund managers rotated their capital away from India. Consequently, FII ownership in the Indian market fell below 16%, its lowest level in over 12 years.

The Rupee's Persistent Weakness

The Indian rupee's decline further compounded the issue for overseas investors. The currency depreciated by 5.3% against the U.S. dollar in 2025, breaching the psychologically significant level of ₹90 in December and earning the title of the worst-performing Asian currency of the year. This depreciation eroded the dollar-term returns for foreign investors, creating a feedback loop that encouraged further outflows. The Reserve Bank of India's decision to cut the policy repo rate by 125 basis points to 5.25% to support growth also contributed to the currency's weakness.

US Tariffs and Trade Headwinds

External pressures added another layer of complexity. An abrupt policy shift by the United States resulted in the imposition of a 50% tariff on certain Indian goods, among the highest in Asia. This move threatened India's manufacturing ambitions and contributed to stagnation in foreign direct investment (FDI). The stalled progress on a comprehensive U.S.-India trade deal created uncertainty, impacting export-oriented sectors like textiles, gems, and jewelry. The nation's trade deficit widened to a record $182 billion in the first 11 months of 2025, an 11.3% increase year-on-year.

Domestic Investors as a Stabilizing Force

Despite the massive foreign outflows, the Indian market avoided a major crash, thanks to the robust support from domestic investors. Local institutional and retail investors poured approximately $11 billion into equities in 2025. This strong domestic demand helped the market post its 10th consecutive year of gains in rupee terms, with returns of around 10%. For the first time, household ownership of the market, at 18.5%, surpassed that of foreign portfolio investors, at 17.3%, marking a significant structural shift in market dynamics.

Valuations and Earnings Slowdown

Underlying the investor caution was a slowdown in corporate earnings growth, which made India's premium valuations difficult to justify. The MSCI India index traded at a 65% premium to the MSCI EM index based on price-to-earnings ratios. Meanwhile, earnings growth for MSCI India was projected to slow to 10% for the fiscal year ending March 2026, and Nifty 50 companies posted a weaker-than-expected 7-8% growth in the first quarter. This disconnect between high valuations and moderating earnings was a key reason for the market's stagnation.

Outlook for 2026

Looking ahead, analysts express cautious optimism for 2026. A potential rebound hinges on several critical factors. The finalization of the U.S.-India trade deal, potentially by March 2026, is seen as crucial for restoring sentiment and boosting exports. As Indian market valuations rationalize relative to other emerging markets, FIIs may reverse their selling trend. Furthermore, corporate earnings are projected to recover, starting from the December 2025 quarter, supported by government reforms like GST rationalization and increased public capital expenditure. However, risks from a global slowdown or renewed geopolitical tensions remain.

Conclusion

2025 was a year of reckoning for the Indian stock market. It highlighted the market's vulnerability to global capital flows and external trade policies while also showcasing its newfound resilience, backed by strong domestic participation. While the year ended with India lagging significantly behind its global peers, the correction in valuations and expectations of an earnings recovery provide a foundation for a potential turnaround in 2026, provided key trade and policy challenges are effectively navigated.