Explained: 5 reasons why India’s stock market lagged global peers in CY26 despite strong DII flows
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India’s equity market has struggled to keep pace with global peers in CY26 despite strong domestic institutional flows. The Indian stock market declined 13% in CY26YTD, while in US dollar terms, it slumped 19%. The divergence has been particularly stark as global capital remained concentrated in AI, Big Tech and semiconductor-led opportunities, with South Korea gaining 72%, Taiwan 63%, Japan 32% and the Nasdaq 15%, leaving Indian equities struggling to keep pace.
The sell-off in Indian equities has been driven by a combination of global and domestic factors, ranging from persistent foreign institutional investor (FII) outflows and geopolitical uncertainty to elevated crude oil prices, rising bond yields and changing global capital allocation. However, strong domestic institutional flows have provided a cushion, but have not been sufficient to offset the pressure from foreign investors.
Here are five factors that explain India’s underperformance.
1. FII selling overwhelmed strong domestic flows
One of the biggest reasons behind India’s weak performance was the return of foreign institutional investor (FII) selling. After two months of net inflows, FII selling resumed in September, increasing volatility and erasing the gains recorded by the market by mid-quarter.
Between July and September, domestic institutional investors (DIIs) invested around $18 billion in Indian equities, aided by monthly SIP contributions of more than $3 billion and healthy retail participation. FIIs, however, invested only around $0.7 billion during the period, according to a recent report by Motilal Oswal Financial Services.
The strong domestic liquidity provided a cushion, but it was not enough to offset the uncertainty around foreign flows.
2. Global capital moved towards AI and semiconductors
India also found itself on the wrong side of a major shift in global capital allocation. For much of CY26, investors remained focused on AI, Big Tech and semiconductor-led opportunities, particularly in South Korea, Taiwan, Japan and the US.
The performance gap was stark. South Korea gained 72% in USD terms in CY26YTD, Taiwan 63%, Japan 32% and the Nasdaq 15%. Brazil also remained positive, gaining 15%, supported by higher commodity prices, as per the report.
India, in contrast, declined 19% in USD terms, performing better only than Indonesia, which fell 26%, and Russia, down 23%.
3. Geopolitical risks, crude and inflation weighed on sentiment
The expected cooling in the impact of the West Asia conflict did not materialise during 2QFY27. Instead, uncertainties intensified towards the end of the quarter.
Crude oil prices remained elevated, while global bond yields spiked amid rising inflation concerns. The onset of a rate-hike cycle added another layer of uncertainty for equities.
For India, these global risks coincided with renewed FII selling, resulting in higher market volatility and pushing the market closer to its March 2026 lows. The Nifty stood at around 22,600, while the Sensex was near the 72,600 mark on October 7.
4. Large caps bore the brunt of FII selling
India’s underperformance was not uniform across market segments. Large caps faced greater pressure as persistent foreign selling weighed disproportionately on the segment.
On a CY26YTD basis, the Nifty 50 declined 13%, while the Nifty Midcap-150 fell 2%. The Nifty Smallcap-250, in contrast, gained 7%, supported by strong domestic inflows.
“As overall market sentiment weakens, large- and mid-cap stocks have given up all their gains, closing 5% down QoQ, while small-cap stocks closed flat sequentially despite strong domestic inflows,” Motilal Oswal said in its report.
The earnings outlook also remained relatively stronger for mid- and small-cap companies, while large-cap earnings, excluding oil marketing companies, are expected to lag their smaller peers.
5. Valuations corrected, but India remained behind
The market correction has significantly moderated valuations from their September 2024 peak. Valuations of the Nifty 50, Midcap-150 and Smallcap-250 have cooled 31%, 36% and 7%, respectively.
The correction has helped reduce some of the excesses across the market, with valuations in heavyweight sectors such as consumer, private banks, technology, retail and oil & gas now significantly below their respective long-period averages, as per the report.
Yet the valuation reset has not translated into relative outperformance. Global capital continued to favour markets benefiting from the AI and semiconductor cycle, while the beginning of a rate-hike cycle could shift a meaningful share of capital towards fixed income.
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