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Will FIIs’ return in 2026? Predictions in the past saying ‘FIIs cannot ignore India’, have fallen flat in recent years. This explains why instead of forecasting based on beliefs and biases as many experts have, investors would do well to pay heed to a famous quote of Warren Buffett – ‘Bull markets can obscure mathematical laws, but they cannot repeal them.’
Yes, a sustainable return of FIIs at some point in time in the future is inevitable, but that is likely to happen only when certain conditions prevail in 2026 or later. There is lack of clarity on the timeline, but there is a lot of clarity on the conditions that need to prevail. For them to return on a sustainable basis like they did during much of previous decade, the mathematical laws must support it. Currently, these laws are not supportive, even though there have been some views recently that the ‘QE’ initiated by the US Federal Reserve after the last FOMC meeting on December 10, can bring back FII flows.
The Math
For much of last decade and early years in the current, one of the most dominant theme for investing in equities was TINA or the ‘there is no alternative’ mantra. And that was true — what do investors buy when long-term bonds were yielding zero to two per cent or in some cases even negative in developed economies? This created what can be termed a ‘hunger for yields’ that saw equity valuations move up gradually between 2010 and 2020. For example, Nifty 50 PE (trailing) moved up from a range of 14-18 times during much of 2011-14 to consistently trading at 20 times or above from 2015 to 2020 onwards. During both these phases while it did trade outside this range on and off, those were more like exceptions. Improving investor sentiment and fundamentals apart, a global liquidity gush was also a factor that made investors comfortable with higher valuations. Relative valuation was at play.
The difference between the equity yields (1/PE) and bond yields for an FII was too good to ignore even when the currency risks are factored.
This math has changed in recent years (see chart). With bond yields spiking globally, risk-reward for an FII to buy Indian equity is at its worst in many years. This math is simple and its hard. TINA has been replaced by TAMA — there are many alternatives, that include treasury bonds!
For this to change, Indian market valuations have to temper down (can happen driven by strong earnings growth, or by way of a correction, or both) or bond yields in countries like the US.
Japan and Germany have to decline for the right reasons. Their bond yields can decline by way of two factors — one, inflation is vanquished and bond vigilantes gain confidence to buy long-term bonds (which will bring yields down) or two, there is an economic slowdown or geopolitical issue that triggers a flight to safety resulting in buying of treasury bonds. While the first will be good for FII flows into India, the second will not be.
But what about the ‘liquidity gush’ from recently announced measures by the Fed? Will that not bring down bond yields?
The new ‘QE’
To begin with the Federal Reserve is calling it reserve management as it is only buying short duration bonds. But critics argue any injection of money by the central bank is a form of quantitative easing (QE). Typically in the past, QE money has been used to buy long-term treasuries. QEs in the past have always been positive for equities.
While inflation still remains above target, the Fed insists this liquidity injection move was required to ensure the Fed Funds rate remains within its target range.
In recent months, the target range of the Fed Funds rate was getting tested in the markets, as financial institutions that required liquidity weren’t able to borrow within the target range in few instances. Interest rates across the economy are set based on the target range and if that is breached, it can impact the Fed’s objectives.
In September 2019, the US financial system went through something that is termed as a repo market crisis, when the repo rates on transactions between financial institutions for liquidity management spiked significantly above the Fed Funds rate. While the Fed Funds rate is the rate at which banks borrow from each other (usually unsecured), the repo rate is the rate at which a wider group of financial institutions borrow from each other using high-quality collateral.
Given that the repo transactions are backed by high-quality collateral, it is expected to track the Fed Funds rate very closely. However, when there was unexpected tightening of liquidity in the US in September 2019 due to withdrawal of deposits for tax payments, large treasury issuances and few other factors, this resulted in instances of the overnight repo rates spiking to as high as 10 per cent in short instances versus the Fed Funds rate ceiling at 2.5 per cent then.
Hence, the reserve management or QE (whatever one may call it) that the US Fed is implementing now is to ensure an ample reserves regime, as the signals on tightening of liquidity now were giving the September 2019 vibes.
Despite rate cut and ‘QE’, the long-term bond yields in the US have hardly budged. This QE which is aimed at preventing a drain of liquidity rather than offering a gush, can reduce upward pressure on long term yields, but is unlikely to bring it down unless fundamentals warrant it.
Published on December 20, 2025
