An improvement in corporate earnings in the second half of the year could trigger a revival of interest from foreign investors who have withdrawn over $10.1 billion so far in 2025.

A combination of factors, including weak corporate earnings in the first quarter, the relative underperformance of benchmark indices compared with global peers, and US-India trade friction adding to the risk premium, has influenced foreign institutional investors (FIIs) to look at other geographies.

The US dollar and interest rates also influence FII investment. US 10-year treasuries, trading near 4.2 per cent, are keeping global yields competitive, pressuring emerging market risk premiums.

The Dollar Index — which tracks the relative value of the dollar against six major currencies — has also softened to around 98. A weaker dollar makes investments in theUS less attractive compared with investments in other countries.

As a result, global investors tend to move their money out of the US and into higher-yielding assets in emerging markets. However, with valuations expensive in India, other emerging markets, including Korea, Latin America, and China, have gainedprominence.

“This has triggered profit-taking in India, where valuations are relatively expensive compared with peers. US-India trade frictions and tariff uncertainties have added risk premiums, weighing on flows during July-August. Combined with softer corporate earnings growth, we are seeing persistent FII outflows from Indian markets,” said Devarsh Vakil, head of prime research, HDFC Securities.

“After four consecutive months of inflows, FIIs turned net sellers in July 2025, with the trend persisting in August so far. FII outflows are being driven by a mixed Q1 earnings season and global headwinds such as a strong dollar and ongoing US–India trade frictions,” said Sneha Poddar, vice-president — research, wealth management, Motilal Oswal Financial Services.

While FII investments were outbound, domestic institutional investors (DIIs) have kept the markets steady, clocking as net buyers for the 24th consecutive month. Total inflows from DIIs to date in 2025 amount to $48.5 billion (see charts 1 and 2).

Expensive valuations

The Nifty 50 has underperformed relative to the global markets, which is evident in the 3-month, 6-month and 1-year returns. India continues to trade at a premium against its peer Asian economies, as is evident in its high price-earnings ratio compared with the MSCI Emerging Markets Index.

At present, the Nifty 50 trades at a premium of over 62 per cent against the MSCI emerging markets index, which is above the long-term average of around 52 per cent (see charts 3 and 4).

“While this confirms Indian equities remain expensive relative to peers, the ratio has declined from approximately 85 per cent in December 2024, indicating India’s recent underperformance against other emerging markets has begun narrowing the valuation gap,” said Vakil.

The US–India geopolitical tensions have also influenced FII sentiment in recent months, amplifying short-term caution and accelerating portfolio shifts toward cheaper emerging markets.

“Mid-2025 US tariffs and stalled trade negotiations have created policy uncertainty. While the economic impact remains manageable given India’s diversified exports, these developments have added risk premiums to equity valuations and heightened FII caution,” he said.

Triple triggers

Corporate earnings for Nifty-50 companies have shown growth of 8 per cent, which is lower than what analysts were expecting. A delayed recovery in urban demand, unseasonal monsoon and tariff-related uncertainties have weighed in on the performance, which in turn has contributed to short-term FII outflows.

“The Nifty 50 earnings estimates for 2025 and 2026 have been cut by 2.8 per cent and 1.8 per cent in the last three months, taking the year-to-date cuts to 7.7 per cent and 6.0 per cent, respectively. As of July 31, 2025, projected earnings growth for 2025 and 2026 stands at 10.5 per cent and 14.7 per cent,” the August edition of the market pulse report of the NSE, quoting LSEG (London Stock Exchange) analysis (see chart 5).

“The steep earnings downgrades for FY26 since the end of December were broad-based across sectors, primarily led by commodity sectors, consumer discretionary, IT and financial services. While commodity sectors were hit by rising global geopolitical and trade uncertainties and consequent hit to global demand, financials felt the heat of weakening credit offtake.

“The IT sector was weighed down by weakening global demand for IT services amid a slowing growth outlook. Downgrades in consumption-oriented sectors reflect the impact of slow urban demand,” the report said.

However, a combination of fiscal and monetary measures — personal tax rebate announced in the budget, a decision to bring down the number of GST slabs, and the RBI lowering the benchmark repo rate by 100 basis points in 2025 to boost credit offtake and support growth — are expected to provide the impetus to demand and improve corporate earnings in the second half of the ongoing financial year.

“We anticipate significant acceleration with double-digit Nifty earnings growth this year, driven by a stronger second half,” Vakil said.

“An improved corporate performance will likely be crucial for attracting FII flows back to India,” he added.

“While the Indian equity market has been volatile over the past two months owing to tariff jitters, we believe that improved earnings prospects and reasonable valuations (barring small-caps) should enable the market to achieve modest gains,” Motilal Oswal said in a report.