India's Valuation Premium Declines: A Turning Point for Foreign Investors?
The landscape of emerging market investments is undergoing a significant transformation as India's once-substantial valuation premium over its peers has contracted dramatically. This development raises a crucial question for global portfolio managers: has the Indian equity market finally reached a level where foreign institutional investors (FIIs) might consider returning in force?
The Shrinking Premium: From Peak to Correction
For several years, international investors demonstrated remarkable willingness to pay extra for exposure to Indian equities. This premium was supported by robust economic growth indicators, consistent policy frameworks, and resilient corporate performance that collectively justified higher valuations compared to other emerging economies. However, this cushion has been steadily eroding over the past year.
The data reveals a compelling story of shifting fortunes. MSCI India's premium over the broader MSCI Emerging Markets index climbed steadily from 116% in 2022 to reach a peak of 164% in 2024, coinciding with a powerful bull run in Indian stocks. As markets entered a consolidation phase in 2025, this valuation gap began narrowing significantly, dropping to 119%. The trend has continued into 2026, with the premium falling further to approximately 93% as of late January.
Performance Divergence and Regional Competition
While India's valuation premium has been contracting, its market performance has simultaneously cooled. MSCI India has recorded a decline of 2.6% so far in 2026, marking a noticeable underperformance and loss of regional leadership. This contrasts sharply with the resurgence witnessed in other Asian markets during the same period.
MSCI Korea has surged an impressive 27.6%, MSCI Taiwan has jumped 13.1%, and MSCI China has risen 7.6%. This performance divergence highlights a decisive shift in investor preference away from Indian equities toward other emerging markets offering better returns.
Vinay Jaising, CIO and Head of Equity Advisory at ASK Private Wealth, explained: "India's equity market returns have lagged emerging market peers over the past two years due to a mix of factors." He pointed to the rupee's depreciation of nearly 5% over the past year and 8-9% over two years, which prompted FIIs to reduce positions by approximately $20 billion in calendar year 2025 and another $4 billion in January 2026.
Fundamental Challenges and Structural Concerns
Beyond currency movements, several fundamental issues have contributed to India's market underperformance. Jaising highlighted a banking liquidity crunch and consumption slowdown that led to earnings reductions across corporate India, further aggravating equity performance last year.
He noted that India's market capitalization-to-GDP ratio currently stands at 130%, significantly higher than other emerging economies such as China (75%), Indonesia (58%), and Brazil (48%). Additionally, India's earnings growth has been modest at 3-4% in FY26 so far, compared to 20-22% for emerging markets overall.
Jay Kothari, Senior Vice President and Global Head of International Business at DSP Asset Managers, identified another critical factor: "A key factor behind India's relative underperformance is its perception as an 'anti-AI trade', given the lack of listed AI-related stocks." This perception has driven capital reallocation toward markets like Korea, China, Taiwan, and the United States that offer greater exposure to artificial intelligence themes.
Potential Recovery Signals and Cautious Optimism
Despite these challenges, some experts detect emerging signs of stabilization. Jaising suggested that "most of the fundamental reasons are behind us" and emphasized India's superior economic growth compared to other emerging markets. He also noted India's significant weightage in EM indices, second only to China, and expressed confidence that earnings growth would recover.
Kothari offered a measured perspective: "We believe that many of these negatives are factored in, and if we continue to see earnings recovery and policy support, along with reducing foreign selling, India could be bottoming out." He suggested that long-term investors might consider adding exposure to Indian equities at current levels.
Market participants generally agree that several factors could provide much-needed support to Indian stocks:
- Improving corporate earnings momentum
- Policy support on both fiscal and monetary fronts
- A stabilizing rupee exchange rate
- Reduced foreign selling pressure
Brokerage Caution and Structural Questions
Not all observers share this cautiously optimistic outlook. Kotak Institutional Equities struck a more reserved tone in a recent report, questioning whether India's market correction and continued underperformance represent a temporary blip or the beginning of a permanent reset to more realistic valuation multiples.
The brokerage warned that rising disruption risks across sectors, combined with limited investment by Indian companies to counter these challenges, could eventually drive structural de-rating of multiples. Their analysis suggested that "the de-rating has been delayed by the price-agnostic purchases of retail investors" who have continued buying despite valuation concerns.
As India's valuation premium continues to normalize, the investment community remains divided on whether this represents a buying opportunity or signals deeper structural issues. The coming months will reveal whether reduced premiums can indeed attract foreign capital back to Indian shores or if further adjustments are necessary before FIIs return in meaningful numbers.
