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The Indian stock market has been experiencing significant turmoil over the past five months, with share prices plummeting, market indices dropping sharply, and investors facing colossal losses. An estimated Rs.94 lakh crore has been wiped out from the market during this period. Both the Sensex and Nifty indices have declined by approximately 16%, marking the steepest fall in three decades. February 2025 was particularly devastating, with Rs. 40 lakh crore in investor wealth eroded.

The market capitalization of BSE-listed companies has dropped dramatically from Rs.478 lakh crore in September 2024 to Rs.384 lakh crore by the end of February 2025.

The key question is: What has caused this massive downturn in the Indian stock market? The primary factor identified is the large-scale offloading of investments by Foreign Portfolio Investors (FPIs). Since October 2024, FPIs have withdrawn about $29 billion from Indian equities—the largest outflow in any six-month period. In just the first half of March 2025,

FPIs have sold Indian stocks worth $3.5 billion, with the technology sector facing the highest divestment, followed by the consumer goods sector. Interestingly, almost all of the funds withdrawn from India have been redirected to the Chinese stock market.

But why are FPIs moving their investments from India to China? What has made the Indian market, once a top investment destination, so unattractive to them? Has there been a significant policy shift that discouraged FPIs? Has the Indian economy performed poorly? Have corporate profitability levels plummeted? Or is the future outlook for the Indian economy and industry so bleak that investing in Indian stocks now poses a significant risk?

The reality is that none of these concerns hold. Post-COVID, India’s economy has outperformed most global economies. With a cumulative real GDP growth of 20% between 2019-20 and 2023-24, India remains one of the world’s fastest-growing economies. Since 2021-22, GDP growth has consistently exceeded 8%, the highest globally. Moreover, corporate profitability in India has remained robust. The combined net profits of India’s top listed non-financial companies have grown at a compound annual growth rate (CAGR) of 32% over the past five years, a significant improvement from the 7.4% annual growth seen between 2014 and 2019. The 22.3% profit growth recorded by 4,000 listed companies in 2023-24 has been the highest in 15 years.

The Indian stock market has also outperformed its Chinese counterpart over the last five years. The NIFTY 50 index has shown 16.7% higher growth than China’s Shanghai Composite Index. Additionally, India’s stock market has demonstrated remarkable consistency, delivering positive returns for six consecutive years, unlike China’s more volatile market, which has experienced negative returns in at least two of those years.

Given these strong fundamentals, what could explain the sudden withdrawal of FPIs? While a few recent factors might have dampened investor sentiment, their impact seems in-sufficient to justify such a massive exodus:

Revised GDP Growth Projection: India’s GDP growth rate for 2024-25 has been revised to 6.5%, the lowest in four years. However, it still remains the highest among major global economies. In contrast, China’s projected GDP growth for the same period is 4.6%.

Corporate Profit Growth Slowdown: While corporate profit growth has slowed, the overall profitability of Indian companies remains strong, and proactive measures are being taken to address the issue.

Capital Gains Tax Changes: The long-term capital gains tax has been increased to 12.5%, and indexation benefits have been abolished. However, China’s capital gains tax is set at a flat rate of 20%, making India’s tax structure comparatively favorable.

High Interest Rates: India’s interest rates remain on the higher side, but the recent reduction in the RBI’s repo rate is expected to lower borrowing costs and improve liquidity, ultimately boosting corporate investment and economic growth.

Thus, from an economic standpoint, there seems to be no concrete justification for such drastic FPI withdrawals from India in favour of China. This suggests that factors beyond economic logic are at play.

The role of Market Psychology and Investor Sentiment

FPI investments are not driven solely by economic fundamentals; market psychology, or “animal spirits,” also plays a crucial role. Animal spirits refer to investors’ emotions—confidence, optimism, fear, or pessimism—which influence financial decision-making. FPIs constantly seek high and fast returns, often prioritizing speculative gains over long-term economic logic.

China’s recent economic policies and developments, such as targeted stimulus measures and advancements in artificial intelligence (AI) through ventures like Deepsake, have fueled a perception among FPIs that China’s market holds greater profit potential. The belief that Chinese technology stocks will experience rapid growth has likely motivated FPIs to exit Indian tech stocks in favor of their Chinese counterparts. Moreover, FPIs perceive Chinese stocks as undervalued compared to Indian stocks, leading them to anticipate higher absolute returns in China.

However, these perceptions may not necessarily align with economic reality. While China is the world’s second-largest economy and a global manufacturing powerhouse, its recent economic performance has been inconsistent. Yet, investor sentiment can often create market trends that defy fundamentals. The sheer scale and influence of the Chinese economy have reinforced a strong psychological belief among FPIs that China is on the verge of a major economic resurgence.

The self-correcting nature of markets

Historically, markets driven by excessive optimism or pessimism have witnessed corrections. The Asian Financial Crisis of 1997 and the U.S. Financial Crisis of 2008 were both fueled by speculative investment

decisions that ultimately led to market crashes. Every time such an investment bubble has formed, it has eventually burst, restoring market equilibrium.

Given this, the current situation calls for a “wait and watch” approach. Over time, market fundamentals are likely to reassert themselves, prompting FPIs to realign their investment decisions based on economic reality rather than speculative exuberance. As this self-correcting mechanism takes effect, investor confidence in the Indian market may be restored, leading to a renewed inflow of FPI investments.

Conclusion

The recent turmoil in the Indian stock market is not fundamentally driven by economic distress but rather by the shifting psychology of investors. While certain short-term economic concerns exist, India’s strong macroeconomic indicators, corporate profitability, and market resilience continue to provide a robust investment environment. The massive FPI withdrawal in favour of China appears to be influenced more by speculative sentiment than by actual economic data. As market psychology stabilizes and economic fundamentals regain prominence, the Indian stock market is likely to recover and reaffirm its position as a preferred investment destination.