Foreign investors may continue to remain cautious on Indian stocks even after the artificial intelligence (AI) trade peaks, brokerage Bernstein said. It said foreign investors are unlikely to return in large numbers unless India is able to build industries and companies that can compete globally, making this a key factor for a sustained recovery in foreign investment.Bernstein expects foreign institutional investor (FII) flows to stay flat to slightly positive over the next 12 months. However, it said this would mainly show that some of the recent pressures on foreign investors have eased, rather than a major improvement in the factors that drive their long-term investment decisions.“We do not believe FIIs will return in large numbers even after the AI trade peaks,” the brokerage said.For foreign investors to return in a sustained way, India will need to create “new engines of competitiveness, innovation, and global relevance”, Bernstein said.The brokerage said India needs to show stronger capabilities in areas such as advanced semiconductor manufacturing, batteries and energy storage, and energy self-sufficiency.It also needs businesses that can win a meaningful share of global markets, Bernstein said.There are some early signs of this in sectors such as space, defence, semiconductors and deep-tech. However, most of these sectors are still too small to have a major impact on global investment decisions, it said.The comments come after a sharp change in foreign investment flows into Indian equities. FIIs have pulled out USD 40 billion from Indian stocks over the last two years.Over the past 24 months, FIIs recorded combined outflows of USD 56.3 billion. This compares with inflows of USD 38.6 billion in the 24 months before that.Bernstein said the link between India’s economic growth and FII flows has weakened. The earlier link between the interest-rate difference between India and the US and FII flows has also faded.Foreign investors are now paying more attention to currency movements, relative valuations and changes in expected earnings, the brokerage said.The rupee has become an important factor in FII flows. Bernstein said the correlation between FII flows and the currency has risen above 70% in recent years.This may mean that a weaker rupee is reducing the returns foreign investors get when their investments are measured in US dollar terms, it said.High valuations have emerged as another factor.Bernstein said its analysis showed that rising relative valuations have gone along with weaker FII flows in recent years, making it harder to attract foreign capital.The brokerage expects FII flows to remain flat to modestly positive over the next 12 months. But it said this would mainly reflect an easing of recent headwinds and not a major improvement in the factors that drive long-term foreign investment.For a sustained return of foreign capital, Bernstein said India will need to create a new generation of globally competitive companies and build new sources of competitiveness, innovation and global relevance.
