finance
A robust financial sector is vital for the economic development of any nation. With liberalized economic policies and the globalization of asset markets, emerging economies are increasingly attractive for investors seeking higher returns. This expectation fuels capital influx into these burgeoning markets from both foreign and domestic investors. As the global economy faces challenges, it is essential to analyze the Indian economy in relation to other major economies, particularly considering the volatility of the Indian Stock Market. Understanding the sentiment shifts among Foreign Portfolio Investors (FPIs) and Domestic Institutional Investors (DIIs) is critical in this context.
The Indian Stock Market has faced unprecedented withdrawals from FPIs, totaling Rs. 2.37 lakh crore as of 2025—the largest pullback in its history. Several factors contribute to this withdrawal, including an increased tax surcharge and the introduction of a buyback tax. The decline began in October 2021, driven by global inflation concerns. Other influential factors include:
FPIs typically lead to stock market index increases, while their outflows trigger declines, amplifying market volatility—a key determinant in investment decisions, defined as the degree of price variation over time.
Domestic Institutional Investors (DIIs), which encompass banks, insurance companies, and mutual funds, play an essential role in market dynamics as well. While FPIs often sell during turbulent periods, DIIs have invested ₹1.2 lakh crore (2025), counterbalancing some losses by increasing their holdings in Nifty50 companies. Consequently, the interaction between FPIs and DIIs is crucial for policymakers, as it informs assessments of systemic risk in India and worldwide.
Major economies, including the U.S. and European nations, face persistent inflation. In response, central banks have enacted tighter monetary policies and raised interest rates. As of April, the U.S. Consumer Price Index (CPI) inflation was recorded at approximately 8.3%, while Europe reported an annual inflation rate of 8.1%. Additionally, the National Statistical Office recently indicated that retail inflation in India, as measured by CPI, has reached an eight-year high of 3.34%. These rising inflation rates have led to significant sell-offs in global financial markets.
Under Section 45-ZA of the RBI Act, 1934, the Central Government, in consultation with the Reserve Bank of India (RBI), determines the inflation target based on the CPI at five-year intervals. A notification issued on March 31, 2021, established the target at 4%, encompassing an upper limit of 6% and a lower limit of 2% for the period from April 1, 2021, to March 31, 2026. The CPI has consistently surpassed the upper tolerance threshold for six months, presenting ongoing challenges for the central bank in managing inflation. In its meeting on June 8, 2022, the RBI raised the repo rate by 40 basis points to 6.5%, suggesting the possibility of further increases in the upcoming quarter. The repo rate, the rate at which the RBI lends to commercial banks, influences borrowing costs, thereby controlling money supply and inflation predominantly driven by rising global commodity and food prices.
Elevated repo rates can dampen future inflation expectations, potentially reducing current inflation levels. While this mechanism may not apply immediately in the Indian context, it has proven effective in developed and emerging markets. Higher interest rates could attract foreign investment, which may strengthen the rupee; however, the Indian currency continues to depreciate against the dollar. Achieving favorable outcomes may necessitate substantial rate hikes in response to regulations from the U.S. Federal Reserve.
Historically, there exists an inverse relationship between repo rates and stock market performance. Adjustments in the repo rate significantly influence stock prices; lower rates foster cash inflows, while rate increases constrain corporate and DII expenditures, hampering market growth. Despite recent interest rate hikes and considerable volatility in global and domestic markets, equity mutual funds witnessed inflows of ₹1.2 lakh crore in May.
In spite of the challenges posed by rising repo rates and substantial FPI exodus, domestic investments appear resilient. The increase in repo rates aims to streamline savings and reduce spending, consequently limiting cash inflows. Nevertheless, the confidence of DIIs in equities signals ongoing optimism among retail investors. This confidence is bolstered by a promising outlook for India's economic growth, with GDP growth projected between 6.2% and 6.8%, fostering a favorable investment climate.