Patience with domestic money will be tested and FPIs could return in 2026

Liquidity chases performance. Assets and markets that outperform others attract liquidity, and that will always be the case; It was no different in 2025. Within the global equity canvas, major markets have almost all outperformed Indian equities. Unlike domestic participants who invest largely in Indian equities, FPIs can choose from a wide range of markets.There has been plenty of discussion about FPIs selling off Indian markets and investing elsewhere, and the following table just illustrates that they have been wise to do so. The depreciation of the Indian rupee against the US dollar has further hurt the dollar returns of foreigners invested in Indian markets.

A closer look at the texture of FPIs’ sales indicates that they are not bullish on India’s technology and consumption story for now as most of their sales were in sectors like IT, FMCG, energy, consumer discretionary and healthcare. Their exposure to BFSI is maximized, which is in line with the weight of space in our markets. They were marginal sellers in that.

Domestic institutional money is driven by private participants, and therefore we are witnessing a flow of liquidity coming into the markets from DIIs, especially from mutual funds. There too, the concentration of funds takes place in Flexi-cap, Mid-cap and Small-cap funds. All things considered, retail money is largely flowing into the mid- and small-cap sector. With the market consolidating due to valuation numbers well ahead of the earnings trajectory, money-making ideas are not easy to find on the secondary market. This in turn pushes domestic liquidity into the primary market, which in turn drives the IPO market. This was the story of 2025.

The year 2026 could be challenging if the government does not announce major capital expenditures, and if credit offtake growth does not exceed 9-11%, which we believe may not be the case. The best-case scenario for the market seems to be a few more quarters of consolidation, which will put the market in a cheap valuation zone. This could see FPIs come back into our markets as underperformance against other global markets, valuation comfort and a depreciated currency would be the right combination for them to invest. We are already witnessing a declining pace in their sales. The biggest risk to this best-case scenario would be an increase in retail loan delinquencies due to tensions in some part of the economy. This could lead to FPIs reducing their exposure to the scared sector called banking, which could ultimately lead to a correction in the market, making this our worst-case scenario.

The flow of money to domestic institutions could be tested in 2026. If next year also proves to be a year of no or low returns, we could see a turnaround in liquidity, and if accompanied by a correction, it could lead to further changes in the direction of liquidity. However, if this happens, FPIs may be on the other side to absorb this shock. It is wise to take into account that this shock absorber will mainly be located in the room with the large hood. Against this background, we believe that equity portfolios should have more weight in large caps by 2026. Dips should selectively take into account exposure to mid- and small-caps.

(The author is Head – Institutional Research, Asit C Mehta Investment Intermediates Limited)