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India’s equity market has remained resilient despite heavy foreign outflows. Can domestic investors sustain this momentum, or is turbulence ahead?

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Foreign Investors Exit, But India’s Equity Market Holds Strong

Since late 2024, foreign institutions have been aggressively offloading Asian equities, particularly in India, as the likelihood of a second Donald Trump administration increased. Despite this, India’s stock market has shown remarkable resilience, largely due to a surge in domestic investments. While other Asian markets have struggled to compensate for foreign outflows, India’s investor base appears to be holding the fort. But will this trend continue?

Robust Domestic Inflows Cushion the Impact

Between October 2024 and early 2025, foreign investors have pulled out approximately $39.5 billion from Asian equities, with nearly half of these withdrawals occurring in India. Despite this massive sell-off, the Bombay Stock Exchange (BSE) Sensex has only declined by 10% from its September 2024 peak.

One of the key factors mitigating the downturn has been a surge in domestic investments. Retail investors and domestic institutions have been pouring money into Indian equities, with contributions through Systematic Investment Plans (SIPs) reaching unprecedented levels. These investment plans, which allow individuals to make fixed monthly contributions to mutual funds, have seen average inflows of $2.7 billion per month in 2024, peaking at $3 billion in the three months leading up to January 2025.

This steady stream of domestic investment now constitutes nearly half of all local institutional inflows, acting as a crucial buffer against foreign capital flight.

India’s Unique Position in the Asian Market

India’s ability to sustain domestic equity investment stands in contrast to other Asian markets. South Korea, despite having a strong local investor base, has experienced consistent selling pressure from domestic institutions over the past five years. Similarly, Malaysia, another market with significant local participation, has struggled to generate sufficient domestic buying power to offset large institutional sell-offs.

India’s relative resilience stems from a historical underinvestment in equities, which is now reversing. Over the past decade, Indian households have traditionally allocated less than 2% of their gross financial savings to the stock market. This figure briefly spiked in 2016 due to policy changes but fell back to 3.3% by 2021. However, a shift is now underway, with equity investments surging to 7-8% of household savings in recent years.

Despite this increase, Indian households still allocate far less to equities than their counterparts in countries like South Korea and China, where stock market participation is significantly higher. This suggests there is still ample room for growth in India’s equity market.

The Digital Revolution and Easy Access to Investing

One of the main drivers behind the rising equity investments in India is the increasing ease of market access. A combination of widespread smartphone adoption, affordable trading platforms, and the rapid opening of dematerialized (demat) accounts has fueled retail investor participation.

From 2020 to 2024, the number of demat accounts in India skyrocketed from 40 million to over 150 million, enabling millions of first-time investors to enter the stock market. Fintech advancements have made investing as simple as a few taps on a mobile app, attracting a new wave of younger investors eager to grow their wealth.

Outpacing Inflation: The Search for Higher Returns

Another compelling reason for the growing appetite for equities is the need to outpace inflation. Over the past five years, India’s Consumer Price Index (CPI) has fluctuated between 2% and 8%, peaking at 7-8% in 2022-23. Traditional asset classes like real estate and fixed deposits, once favored by Indian investors, have struggled to keep pace with inflation.

Real estate, long considered a stable investment, has underperformed equities for nearly a decade. Meanwhile, fixed-income investments, such as government bonds, no longer offer the high yields they did in the 1990s and early 2000s. Back then, Indian 10-year bonds provided yields between 10-15%, but this has now declined to a more modest 5-8%.

In theory, the negative yield gap—where the stock market’s earnings yield falls below bond yields—should make equities less attractive. However, optimism about long-term growth prospects appears to outweigh concerns about overvaluation.

Storm Clouds on the Horizon?

Despite the current strength of India’s domestic investor base, challenges lie ahead. The Nifty 50 index has dropped 10% over the past five months, raising concerns that retail investors—accustomed to stellar market returns—may hesitate to keep buying at these levels.

Valuations in the Indian stock market remain elevated, with some analysts suggesting that attractive investment opportunities are becoming scarce. Leading asset managers have hinted that the market may be entering an overheated phase, potentially leading to corrections.

The Reserve Bank of India (RBI) could intervene by cutting interest rates or injecting liquidity into the financial system. However, external factors—particularly inflation trends and interest rate policies in the United States—could limit the RBI’s ability to maneuver.

A Temporary Shift or a Lasting Trend?

The coming months will be a litmus test for India’s retail investors. If they continue to pour money into equities despite market volatility, it could signal a lasting transformation in India’s investment culture. However, if recent market weakness shakes investor confidence, the country’s equity resilience could face serious challenges.

Regardless of short-term fluctuations, the long-term trajectory appears promising. With digital financial inclusion expanding, younger generations embracing stock market participation, and a growing awareness of equities as a wealth-building tool, India’s market could remain an attractive destination for years to come.

Source:  (Reuters)

(Disclaimer: The information in this article is based on publicly available data and expert analyses. Market conditions and financial investments are subject to change. Readers are advised to conduct their research and consult professional advisors before making investment decisions.)

 

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