Why strong US growth will make it harder for foreign investors to come back to India

Why strong US growth will make it harder for foreign investors to come back to India

A surprisingly strong US growth has once again tilted the balance in favour of American assets, dimming hopes of a quick comeback by foreign investors into Indian stocks and bonds. This, especially when global capital is chasing safety in gold and silver, hunting for the next wave of growth via AI and new technologies, and recalibrating portfolios amid geopolitical uncertainty and shifting trade dynamics.

The US economy expanded at a 4.3% annualised pace in the third quarter of 2025, its fastest in two years. Consumer spending stayed resilient, government spending held up and exports surprised on the upside. Wall Street cheered. Emerging markets, predictably, are forced to reassess.

When the US Grows Strongly, Rate Cuts Get Pushed Out

Strong growth usually sounds like good news for everyone. In markets, it comes with a catch.

The better-than-expected GDP number has made it harder for the US Federal Reserve to rush into rate cuts. With inflation not fully tamed and the labour market refusing to cool meaningfully, the Fed suddenly has the luxury of patience.

Bond markets reflected that reality. The two-year US Treasury yield — most sensitive to near-term Fed policy — stayed above 3.5% even after the GDP release.

This is despite President Donald Trump publicly saying he expects his next Fed chair to cut rates if markets are doing well, and making it clear he wants a nominee aligned with lower borrowing costs as he nears a decision to replace Jerome Powell. Treasury Secretary Scott Bessent has also floated the idea of reconsidering the Fed’s 2% inflation target once price stability is firmly restored.

But bond markets aren’t convinced. With growth this strong and jobs still plentiful, it’s difficult to build a case for rapid rate cuts — regardless of political messaging. For India and other emerging markets, that means the global liquidity tap is unlikely to open fully anytime soon.

The message from US Treasuries to global investors is blunt: if you can earn decent dollar returns with limited volatility, why take extra risk elsewhere?

That’s not great news for emerging markets, including India.

The Rupee Slide Adds to the Unease

For India, the challenge is compounded by the currency.

The rupee has been under sustained pressure, hitting a record low of ₹91.07 to the dollar, marking one of its weakest phases in years. It’s bounced back a bit now, but remains tentative.

Exporters and policymakers may see a weaker currency as helpful — especially at a time when India is still waiting to clinch a trade deal with the US — but foreign investors tend to see it very differently.

Currency weakness eats into dollar returns and raises hedging costs. Forward premiums have jumped to multi-year highs, signalling that markets are bracing for continued volatility, even as the RBI quietly works the levers behind the scenes.

For global funds, that’s another reason to stay cautious.

Some Comfort on Trade — But Not Enough

There are, of course, some positives.

India’s recent trade numbers have been reassuring. Exports are quickly finding alternative destinations, and the trade deficit has narrowed faster than many expected, helping calm macro nerves.

Then again, trade strength alone doesn’t bring foreign equity investors rushing back — especially when markets haven’t delivered standout performance. India has been among the worst-performing major equity markets globally this year, while the rupee has also seen one of the sharpest declines.

Currency strategists argue that on a REER basis, the rupee now looks undervalued — theoretically strengthening the case for investing in rupee assets. In practice, that’s a hard sell. Investors — retail or institutional — chase performance. Without a clear signal of a turn, and a change in narrative, especially on the India–US trade front, attracting foreign portfolio investors is difficult.

Even the AI Bubble Fear Has Faded

Another factor working against India: the global AI trade hasn’t cracked.

Fears of an AI bubble bursting — a popular narrative just weeks ago — have eased after only minor corrections. Big tech stocks have continued to edge higher on earnings resilience, keeping global investors comfortable staying put.

That removes yet another trigger for capital rotation into markets like India, labelled the “anti-AI trade” in recent months. It’s hardly a badge of honour to be the backbencher in a technology that could reshape the global economy — but for now, that perception persists.

Foreign Flows Are Telling Their Own Story

The flow data underlines the caution.

Foreign portfolio investors have sold roughly ₹1.6 lakh crore of Indian equities so far in 2025, across both primary and secondary markets. This is the highest on record for any year and surpasses the previous peak in 2022.

Hopes of India attracting more than $25 billion of bond inflows following its inclusion in the JP Morgan bond index have also fizzled out, reinforcing how dependent flows remain on global macro conditions.

This leaves India in a delicate position. Policymakers are trying to support growth through fiscal and monetary measures, accept a weaker currency to maintain export competitiveness amid tariff pressures, and offset global headwinds — none of which are particularly friendly for attracting foreign capital in the short term. Ultimately, everything comes back to how these trade-offs play out in corporate earnings.

Domestic Money Is Holding the Fort — For Now

Thus far, domestic investors have been the pillar of support keeping markets steady. But even here, cracks are showing. Retail participation is easing, market breadth has narrowed, and trading volumes have slipped.

That’s one reason foreign money still matters. A return of FPIs could provide much-needed support to markets that currently feel stuck in a bind.

So What Would Make FPIs Look at India Again?

Ask fund managers what would change the mood, and the answers are remarkably consistent:

1) Clear signs that global interest rates are heading meaningfully lower

2) A visible pickup in India’s earnings growth, beyond a narrow set of large stocks

3) A steadier rupee, with lower volatility and predictable hedging costs

4) Valuations also remain a hurdle. Indian equities are still trading near long-term averages — not cheap enough to compensate for global uncertainty from an FPI lens.

So as January begins, no one is standing by with a large India allocation cheque. But market moods change — and can change quickly. This time last year, India was optimistic about a swift trade deal while the rest of the world worried; the year ended with the roles reversed. This year, expectations are far more muted. And yet, a year from now, we may well look back with some surprise at how decisively the narrative shifted again.