Kotak Institutional Equities has said Indian markets may continue to see muted foreign portfolio investor inflows as the country’s external capital dependency has become more visible over the past two years. The report said a sharp slowdown in net FDI flows and a rise in FPI outflows have coincided with a higher current account deficit driven by elevated global energy prices.

Large capital inflows until FY2024 had offset India’s structural trade and current account deficits, but Kotak said this vulnerability may persist without a structural fix to the high CAD. According to Kotak, lower capital inflows and a weaker current account position have reduced the capital account buffers available to absorb India’s existing structural trade deficits.

The report said India’s CAD may weaken further in FY27 if crude oil prices remain high, which would add pressure on the overall balance of payments. Kotak also noted that while a combination of high current deficits and large capital surpluses had sustained the BoP until FY24, the rising cost of servicing the growing stock of external capital is now adding to both CAD and BoP challenges.

Kotak said the weakness in net FDI flows is being driven by a steady increase in gross FDI outflows by both foreign and Indian entities, rising from $15 billion in FY21 to $28 billion in 9MFY26. The report added that Indian companies may continue to pursue outward investments because of geographical expansion plans and technology acquisition needs.

It said gross FDI inflows from overseas entities have held up, but these have been nullified by large outflows from private equity and venture capital investors through exits from their existing holdings in India, and by multinational companies through offer-for-sale transactions in the primary and secondary markets for their Indian subsidiaries.

Kotak also expects gross FDI outflows by foreign entities to remain elevated because PE and VC investors continue to hold significant stakes in large Indian listed and unlisted companies. The report said PE and VC investors currently hold $32 billion at current valuations in large listed entities, with even larger holdings in unlisted entities.

The report said that much of the gross FDI outflows by overseas entities in recent years has come from selling by PE and VC investors and from the listing of MNC subsidiaries in India, where OFS made up a large share of the primary issue amount. On portfolio flows, Kotak said FPI inflows may stay muted because India is less attractive than other emerging markets on several counts.

These include weaker relative FY2027E earnings growth in both quality and quantity, negative exposure to the ongoing AI and semiconductor cycle that may continue for another one to three years, and negative exposure to commodities, especially crude oil and natural gas.

Kotak said other emerging markets offer higher exposure to the AI and commodity cycles, while continued large FPI outflows from Indian equities reflect a steady deterioration in relative returns and continued compression in relative earnings growth expectations.

Overall, Kotak said India is facing a combination of slower net FDI, elevated gross FDI outflows, sustained PE and VC exits, muted FPI flows and pressure from high oil-linked current account deficits, a mix that could keep foreign portfolio inflows subdued in the near term.