The cheerful resilience of the Indian stock market has much to do with the harmonious trading tango between the foreign institutional investors (FII) and the domestic institutional investors (DII). The domestic investors have been voracious buyers of equally enthused sell offs by their foreign counterparts, thus neutralising the impact of FII exodus from the market.

Between beginning of January 2024 and first six days of January 2025, FIIs have cumulatively sold Indian equities worth ₹6,733 crore. FIIs consistently sold Indian equities worth ₹7,160 crore in the first six days of the New Year after a muted buying of just ₹427 crore in 2024, as per NSDL data.   

However, the capacity for the domestic market to absorb even such large scale sell-offs by FIIs has also increased significantly. Demat accounts in India, which stood at a paltry less than 4.1 crore in March 2020, have quadrupled since then.

About 4.3 crore new demat accounts have been added in the first 11 months of 2024, implying that the number of the Demat accounts grew by 30.9% between January and November 2024, from 13.9 crore to 18.2 crore. Mutual Fund folios also increased from 18 crore to 23 crore, registering a 28% growth in the same duration.

The AUM of Mutual Funds, which grew three times in the last 10 years, currently stands at 31.2% of Indian Banking deposits. This indicates that investment in the stock-market has become synonymous with ‘savings’ for the average Indian household. A decade ago, the Indian investors had been more risk averse and content to save up in bank-deposits yielding single digit returns. The trend has almost reversed since then and investors shun low return bank deposits as their appetite for risks and the hunger for better returns, both have developed significantly.

However, the question is, how much of that appetite still remains unsated for the domestic investors to absorb the dumping of Indian equities by the FIIs?

Domestic investor appetite in an expensive market

The market cap to GDP ratio, aka the Buffett Indicator, for the Indian stock market stood at 135%. This implies that the current value of the Indian stock market exceeds the productivity of India’s economy by 35%. In simpler terms, the Indian stock market is quite expensive.

Even though India equities is most under owned by Global EM active funds since 2014, relative to MSCI EM, the MSCI India PE premium at 88% is still above the historical average of 62%, though it is currently down by 19 percentage point from the peak.

Sunil Tirumalai, Head of emerging market (EM) and Asia equity strategy at UBS Securities says, “There is a perception that equities are underpenetrated in Indian household balance sheets, but that needs a reality check. For every ₹100 that Indian households have as financial assets, close to ₹25 is already in equities, including that in stocks, mutual funds, and ULIPs. Equity holdings of Indian households are already 60% of their bank deposit holdings. On these metrics, India is far above other Emerging Markets.

As per Tirumalai, in pre-COVID era, the share of equities per ₹100 invested in financial assets used to be ₹9 only. Within mere four years the share of equities in the financial investment basket of an average Indian household has grown by around 280%.

Even though the Indian stock market has seen an unprecedented growth in the number of domestic investors, as indicated by the rise in the quantum of demat accounts, it is also true that F&O trading dominates the transaction landscape of the market. Investment from the perspective of building portfolio value with a mid-term to long-term outlook is quite insignificant as compared to quick-buck trades that a majority of India’s retail crowd seems to focus upon.

Stock sell-off by FIIs in an expensive market which is dominated by trading transactions does not bode well for the DIIs aiming to create value-investment with a mid-term outlook. It is quite expected that the market has been showing unambiguous signs of corrections and red-flags of caution are surreptitiously being raised by many, says a market veteran who chose to remain anonymous. Market has already corrected 10% from its peak by mid December.

Reasons for FII exodus from the market:

With a decline in Profitability, the Interest Coverage Ratio (ICR) of 1,314 companies, excluding banking and finance companies, has fallen to a seven quarter low of 4.27 times in Q2 FY25, as per CapitalinePlus. A low ICR indicates lower operating profits are available to meet interest payments. 

Jiten Doshi, Chief Investment Officer, ENAM Asset Management Company, states that the FII flows are slaves to three things – bottom-line performance of economy, that is, the read key corporate earnings, relative attractiveness, and near-term outlook. There are two reasons for FIIs selling in India, year-end profit booking and shift in references towards alternate opportunities.

As per Sunil Tirumalai, along with the positive news flow about China stimulus, the softening in the Indian macro and earnings momentum since COVID era is also an important factor in FII selling. For a foreign investor with multiple markets to invest into, India, currently, screens quite expensive for some ordinary fundamentals.

A stock with the same growth, RoE and sector is available for roughly half the valuation elsewhere in the Emerging Markets universe as compared to what one would pay in the India markets. Against this, India is among the few markets having seen earnings cuts this year, and rapidly weakening macro growth. While Trump coming back to power may not have direct rub-off on India, it does make EM and Asia as unattractive risk-reward assets, and hence the weakness is at the EM and Asia level.

Cumulative factors of news about Chinese stimulus, uncertainties linked to US elections, softer corporate earnings from India, and the ambiguity rising from centre and state elections in India have contributed to large scale selling by FIIs.

Outlook for 2025

The Indian corporate earnings trajectory is experiencing a significant recalibration. After an exceptional 21% earnings CAGR from FY21-24, the growth momentum has decelerated, with FY25 Earnings projections softening to sub-10% levels. Fiscal consolidation and regulatory-induced credit contraction have prompted systematic analyst downward revisions.

As per Doshi of ENAM, global economic projection for CY25 remains tepid, hovering around 3.2%, which is a modest level approximately 30-40 basis points beneath pre-pandemic benchmarks. Indian equity market dynamics are undergoing a complex recalibration, with estimated supply of ₹7.5 lakh crore, marginally exceeding the demand of ₹6 lakh crore, amid tepid foreign institutional flows. Valuation metrics remain elevated, necessitating a discerning sector approach, opines Doshi.

One of the major uncertainties of 2025 will be the transition of power in the USA. Historical patterns reveal that post-2016 trade growth has been predominantly driven by US import volumes and Chinese export strategies and Trump’s policies are expected to cause turbulence in both US imports and Chinese exports. The markets across the world are cautious in their outlook rather than being optimistic about the Trump regime. While the anticipated negative impact on the Chinese trade could bolster the Indian market, there is no certainty about the US being more accepting of Indian goods which calls for careful investments and nimble strategies to adjust to the 2025 market dynamics.

“We are cautious on India heading into 2025, and rate Indian equities underweight in our EM universe. There is a risk of absolute downside returns in equities as foreign selling could continue, earnings and macro momentum stays weak, global uncertainties rise,” states Tirumalai of UBS Securities.

History has shown us that the impact of the Great Financial Crisis of 2008 on India was such that it took 6 years for Nifty to climb back to the peak it had achieved in 2008. With Indian equities already at a premium, a trip down this memory lane would serve a prudent investor in formulating strategies for 2025.

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