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Market Liquidity and Foreign Investor Selling: Experts Weigh In

Concerns over foreign investor selling and soaring Systematic Investment Plan (SIP) inflows have been mounting in recent months, but Deepak Shenoy, founder of Capitalmind, believes the solution lies in expanding investment opportunities rather than restricting money flows. According to Shenoy, India needs more companies to list on stock exchanges, creating a larger free float and allowing growing domestic savings to be deployed across a wider set of businesses.

India's pool of listed companies has not expanded fast enough to absorb the growing flow of domestic capital, resulting in liquidity concentrating in a limited number of stocks. This has led to instances where stock prices move more because of liquidity constraints than underlying business performance. Shenoy noted that some stocks witness outsized moves because of limited free float, allowing a relatively small amount of capital to influence prices.

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The dynamic can be exploited by investors, contributing to instances where stock prices move more because of liquidity constraints than underlying business performance. Shenoy pointed to the Jane Street episode as an example of how even highly liquid stock derivatives can be influenced through movements in underlying stocks. Relatively small sums of capital, around ₹5,000 crore, were sufficient to impact underlying prices.

Increasing free float and bringing more companies to market could improve price discovery and ensure that stock performance is driven more by earnings growth than liquidity flows. However, Shenoy cautioned that such a transition may not be painless. He noted that markets may correct in the short term as a result of increased liquidity.

Beyond the stock market, Shenoy pushed back against concerns surrounding India's external position. He argued that measuring reserves solely in terms of months of imports ignores exports and remittances. India recorded a Current Account Deficit of around $50 billion in FY25, which could rise to approximately $80 billion in FY26. For the first nine months from April to December, the deficit stood at around $30 billion.

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With around $550 billion in foreign exchange reserves and another $100 billion in gold reserves, Shenoy said India effectively has years of coverage against its current account deficit. He added that much of the recent decline in reserves stemmed from foreign portfolio investor outflows and RBI intervention in the currency market.

Shenoy also argued that FPIs should be allowed to buy and sell freely and that attempts to discourage selling by forcing deeper market declines would be counterproductive. He called for broader reforms to FEMA and said the RBI's role as the primary provider of liquidity in the dollar-rupee market should eventually change. Despite near-term concerns, Shenoy remains optimistic about India's long-term growth story, noting that new businesses continue to emerge and that future entrepreneurs are likely to be funded by wealth created from today's successful founders.