FIIs unlikely to return in large numbers without new growth engines in India: Bernstein

Foreign investors are unlikely to return to Indian equities in large numbers even after the artificial intelligence trade peaks, with a sustained revival in foreign inflows depending on India's ability to build globally competitive industries in areas such as semiconductors, batteries and energy storage, Bernstein said in a report.

Bernstein said it expects foreign institutional investor (FII) flows to remain flat to modestly positive over the next 12 months, but cautioned that this would largely reflect easing of recent headwinds rather than a meaningful improvement in the factors that drive long-term foreign investment decisions.

"We do not believe FIIs will return in large numbers even after the AI trade peaks," the brokerage said, adding that a structural revival would require India to create "new engines of competitiveness, innovation, and global relevance."

The report said India needs to demonstrate greater capabilities in advanced semiconductor manufacturing, batteries and energy storage, energy self-sufficiency and businesses capable of gaining meaningful market share globally.

Bernstein noted early signs of this in areas including space, defence, semiconductors and deep-tech, but said most of these sectors remain too small to materially influence global capital allocation.

The brokerage's assessment comes after a sharp change in foreign investment patterns. FIIs have withdrawn USD 40 billion from Indian equities over the last two years, while over the past 24 months they have recorded combined outflows of USD 56.3 billion, compared with inflows of USD 38.6 billion in the preceding 24-month period.

Bernstein said the traditional relationship between FII flows and India's economic growth has weakened, while the earlier link with interest-rate differentials between India and the US has also faded. Instead, currency movements, relative valuations and forward earnings revisions have become more important factors for foreign investors, it said.

The brokerage highlighted the rupee's performance as an increasingly important factor, saying the correlation between FII flows and the currency has risen above 70 per cent in recent years. It said this may indicate that rupee weakness is contributing to lower foreign investment returns in US dollar terms.

Bernstein said high valuations are also making foreign capital more difficult to attract, with its analysis showing that rising relative valuations have coincided with weaker FII flows in recent years.

Bernstein said foreign investors are not merely waiting for the current uncertainties to settle before returning to India. Sustained FII participation, it said, will depend on India creating a new generation of globally competitive companies.