There is a number that explains almost everything happening in Indian markets right now. It is not the Sensex level, not the rupee exchange rate, and not the RBI’s repo rate. It is nominal GDP growth, and for the past three years, it has been running far too slowly.
Foreign institutional investors have been selling Indian equities at a pace that has rattled domestic sentiment. The debate in dealing rooms and on television has swung between alarm and reassurance. The bears say India’s moment has passed. The bulls point to the infrastructure pipeline, the demographic dividend, and the digital economy. Both are partially right. But neither camp is asking the right question.
The right question is this: at what speed is the Indian economy generating nominal income? Because that number, the sum of real growth and inflation, is the engine of corporate earnings. And right now, that engine is running in the wrong gear.
The Arithmetic That Made India Irresistible
Cast your mind back to the mid-2000s, the period that market veterans still describe with barely concealed nostalgia. Between 2003 and 2007, India’s nominal GDP was expanding at 14 to 18 percent annually. That was not an accident or a fluke. It was the result of robust real economic activity combined with an inflationary environment that gave companies genuine pricing power. Revenues grew fast. Earnings grew faster. And foreign investors, always hunting for compounding opportunities, were more than willing to pay 22 to 28 times forward earnings to own a piece of that story.
Here is what people forget about that era: those valuations were not expensive. They looked elevated on a raw PE basis, but on a price-to-earnings-to-growth basis, India was actually cheap. Earnings were growing so rapidly that multiples were being worked down by the companies themselves. That is what a properly functioning nominal GDP engine does for equity markets.
Now compare that to the 2022-2025 window. Nominal GDP has averaged just 8 to 9 percent. The deceleration has been driven largely by lower inflation rather than any dramatic collapse in real activity. India is still growing — reasonably well, in fact. But the disinflationary environment has compressed the pricing power of India Inc., particularly among mid- and small-cap companies that depend on revenue growth to fund their ambitions. In this environment, a Nifty forward PE of 21 to 24 times is not reasonable. On a growth-adjusted basis, it is expensive. The earnings simply have not been growing fast enough to justify those prices.
The Paradox on Your Screen
This is why you have seen something deeply strange in the market over the past eighteen months. Headline benchmark indices kept touching record highs. Television anchors breathlessly reported the milestones. And yet, most investors opened their portfolios to find them going sideways or falling. The majority of stocks were underperforming. Breadth was poor. Participation was narrow.
That is not a mystery. That is what happens when the nominal GDP engine slows and earnings growth becomes uneven. A handful of large, high-quality franchises hold up. The broader market struggles. The rally belongs to an index, not to an economy.
Why FIIs Chose to Leave
Against this domestic backdrop, the global environment offered foreign investors every excuse to reduce India’s exposure. The Federal Reserve’s prolonged high-rate cycle kept the US dollar strong, and Treasury yields elevated, and a strong dollar is a gravitational pull that drags capital back toward American assets. Why take India risk when you can earn 5 percent in US Treasuries?
Then came China. Beijing announced aggressive stimulus measures, and suddenly, Chinese equities trading at roughly half the multiple of their Indian counterparts started looking extremely attractive to value-oriented global allocators. The rotation was swift and significant. Money moved.
Add to this the unfolding story in Japan. Japanese government bond yields have been rising, slowly but unmistakably. The era of near-zero Japanese rates that sustained the yen carry trade, one of the largest sources of cheap global liquidity, is being quietly dismantled. Any sharp yen appreciation would signal a serious carry unwind, tightening global liquidity conditions almost immediately and hitting emerging markets hard. India would not be spared.
The Silver Lining That Nobody Is Talking About
Here is what the headline narrative misses: the painful part of the adjustment is largely done. Indian equities have derated. The rupee has corrected. Forward multiples have compressed. The market has, in effect, done a significant portion of the valuation reset on its own.
What is missing is to trigger the catalyst that flips the PEG equation back in India’s favour.
That trigger is a return to 12 percent nominal GDP growth. It is not a fantasy number. It is what you get when real GDP holds around 7 percent and inflation recovers modestly to the 4 to 5 percent range well within the RBI’s own target band. At that pace, corporate revenues once again grow roughly in line with the broader economy. Headline earnings compound at 15 to 18 percent annually. And a Nifty trading at 20 to 24 times forward earnings suddenly looks not just reasonable, but genuinely attractive, especially if the US dollar softens as America continues to inflate away portions of its own debt burden.
The Prescription Is Clear
The path to FII re-engagement requires three things to come together. First, a meaningful rate reduction by the RBI not a token 25 basis points, but a deliberate policy shift that engineers a reflationary impulse and lifts nominal growth. Second, moderation in the pace of primary market issuance, which has been acting as a persistent drain on domestic liquidity. Third, some easing in global liquidity conditions, ideally a more accommodative Fed and a contained, gradual yen adjustment rather than a disorderly spike.
None of these is guaranteed. Timing is always uncertain. But the structural case for India remains unimpeachable. A young population, improving infrastructure, accelerating digitisation, and ongoing formalisation of the economy, none of that has changed. The current FII selling reflects a cyclical dislocation in growth and liquidity. It is not a verdict on India’s future.
Investors who understand the distinction and who position ahead of the nominal GDP turn while others are still anchored to the gloom will find, when foreign money comes rushing back, that they got in at exactly the right time.
History has shown, repeatedly, that FIIs pay up generously when the Indian compounding engine is firing. They are not gone. They are waiting.
