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The second major development affecting the INR is the sustained outflow of foreign institutional investments from Indian equity and debt markets. Over the past month, FIIs have pulled out approximately $3.5 billion from Indian stocks, marking one of the highest monthly withdrawals in recent years. This exodus has been driven by a combination of global and domestic factors, including rising US Treasury yields, geopolitical tensions, and concerns over India’s fiscal deficit.
The US Federal Reserve’s hawkish monetary policy stance has been a key catalyst. With the Fed signaling fewer rate cuts than previously anticipated, investors have flocked to dollar-denominated assets, leading to capital flight from emerging markets like India. The yield gap between Indian government bonds and US Treasuries has narrowed, diminishing the appeal of Indian debt for foreign investors. Additionally, escalating tensions in the Middle East have further dampened risk appetite, prompting FIIs to adopt a cautious approach.
Domestically, concerns over India’s fiscal health have also weighed on investor sentiment. While the government has reiterated its commitment to fiscal consolidation, elevated spending ahead of general elections has raised doubts. The recent surge in food inflation has added to these worries, as it limits the RBI’s ability to cut interest rates, thereby reducing the attractiveness of Indian assets.
The INR has borne the brunt of these outflows. A sell-off by FIIs typically increases demand for USD, leading to rupee depreciation. The currency’s decline, in turn, exacerbates inflationary pressures by making imports costlier, creating a vicious cycle. To counter this, the RBI may need to consider additional measures, such as raising interest rates or imposing capital controls—though both options come with significant trade-offs.
Market participants are closely watching whether these outflows are a temporary reaction or indicative of a broader trend. If global risk aversion persists, the INR could face further downside. Conversely, a revival in foreign investment—driven by strong corporate earnings or policy reforms—could provide much-needed support.
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