FII flows poised for momentum as US rate cut expectations rise

Foreign institutional investors (FIIs) have shown renewed confidence in Indian equities, pumping in Rs 17,000 crore during the months of April and May 2025. This marked a sharp reversal from heavy outflows seen earlier in the year, with net selling of Rs 78,000 crore in January and Rs 35,000 crore in February. The turnaround in April and May has been supported by cooling inflation in the US, weakening of the dollar index, and more importantly broader optimism around India's structural growth story.

Easing US inflation and rate cut hopes

April 2025 saw the US Consumer Price Index (CPI) rise by just 0.2% month-over-month. On a year-over-year basis, inflation slowed to 2.3%, down from 2.4% in March and significantly lower than the 3.5% levels seen in October 2024. This sustained deceleration in inflation has rekindled hopes that the Federal Reserve may soon pivot towards a more accommodative monetary stance which has been put on hold since December 2024.

While the Federal Open Market Committee (FOMC) has not yet re-initiated rate cuts post Dec 2024, it has maintained a data-dependent approach, reiterating that policy adjustments will be made if risks to its inflation or employment objectives emerge.

One such emerging risk is the inflationary impact of potential trade tariffs, notably following former President Donald Trump’s sweeping tariff proposals. This poses a conundrum for the Fed—while inflation is easing, tariff-induced price pressures could complicate the timing of rate cuts.

Nevertheless, the trajectory of US rates remains crucial for global capital flows, especially for emerging markets like India.

Why lower US rates matter for India

Emerging markets are inherently sensitive to US interest rates due to their impact on global capital costs and risk premiums. At present, the US is offering a nominal return of around 5% (2% real growth plus 2-3% inflation). In comparison, India offers a nominal return of approximately 10–11%, based on a 6% real growth and 4–5% inflation. This results in a substantial 5-6% risk premium, which becomes increasingly attractive to global investors as US yields moderate.

Additionally, the US dollar index (DXY) has declined from around 104 at the end of March to nearly 100.80 now, with lows of 98.3 recorded around April 21.

A weakening dollar improves the relative returns of emerging market assets and reduces currency-hedging costs for foreign investors. This further incentivizes capital allocation to markets like India, where access is relatively easy and liquidity is deep.

India’s unique value proposition

India remains one of the most compelling emerging market destinations for FIIs. As the world’s fifth-largest economy—yet still at a relatively low per capita income level—it offers a rare combination of scale and growth. The structural drivers, including a young demographic, rising consumption, and formalization of the economy, continue to attract long-term foreign capital.

Moreover, Indian equity markets are among the most liquid and transparent in the emerging market universe. Regulatory ease, well-developed financial infrastructure, and strong corporate governance norms make it easier for FIIs to deploy capital at scale.

However, one must not lose sight of the fundamentals. Sustained foreign inflows are contingent on the robustness of India Inc.’s earnings trajectory which has been disappointing for a few quarters. As long as corporate earnings growth comes back and becomes broad-based, India is very well-positioned to outperform its peers.

Outlook

Looking ahead, FII flows into India are likely to remain strong, especially if the US Federal Reserve signals a shift toward lower interest rates. With inflation appearing to be under control and macroeconomic stability holding up, India stands to benefit from a reallocation of global portfolios towards high-growth emerging markets.

Nonetheless, global uncertainties—ranging from geopolitical developments to tariff policies—could lead to bouts of volatility. Investors will be watching key Fed commentary and India’s quarterly earnings season closely. But with its economic resilience, reform momentum, and earnings visibility, India appears well-poised to continue attracting global capital in the months ahead.

(The author, Rajkumar Singhal, is the CEO of Quest Investment Advisors)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of the Economic Times)