Experts say India’s growing reputation as an unfavorable destination for artificial intelligence-related investments, coupled with the economic strain caused by the prolonged conflict in the Middle East, has triggered a record outflow of foreign capital from the country.
“India is no longer the obvious, one-way growth story investors assumed it was a few years ago,” said Alexandra Hermann Prasad, Lead Economist at Oxford Economics. She noted that while the Indian economy remains strong by global standards, it is facing increasing pressure from weaker consumption, fragile investment sentiment, rising energy costs, and a more selective global capital environment.
Foreign portfolio investors have sold Indian equities worth .5 billion so far in 2026, following sales of .9 billion in 2025. The sustained withdrawal of capital reflects growing caution among international investors toward Indian markets.
On the foreign direct investment front, India attracted more than billion in gross capital on a trailing 12-month basis ending January 2026, marking a 13 percent increase compared to the previous year. However, the gains were offset by higher repatriation of capital by foreign companies and increased overseas investments by Indian firms. As a result, net foreign direct investment declined to a level described as near an all-time low.
The capital outflows have significantly weakened the Indian rupee against the United States dollar at a time when global crude oil prices are rising. The situation poses a major challenge for India, which imports more than 85 percent of its crude oil requirements.
Economists warn that the economic shocks stemming from the Middle East crisis are gradually being passed on to consumers, increasing inflationary pressures while slowing economic growth. These developments are further reducing India’s attractiveness among global investors.
Last Friday, the Reserve Bank raised its inflation forecast for the financial year ending March 2027 to 5.1 percent and revised its growth projection downward to 6.6 percent from an earlier estimate of 6.9 percent. The central bank warned that the economy is likely to expand at a slower pace than previously anticipated.
In an effort to stem the outflow of capital, the Indian government announced a series of measures last Friday, including exempting capital gains tax for foreign investors participating in the Indian bond market. While analysts welcomed the reforms as timely, many argued that deeper structural changes are necessary to restore investor confidence.
“I think it helps the mood music, but it doesn’t change the symphony,” said Stephen Davies, Chief Executive Officer and Founder of Javelin Wealth Management. He emphasized the need for more market-friendly policies to improve India’s investment climate.
Concerns over the pace of reforms have also intensified. According to the CSIS India Reforms Scorecard, which tracks progress on 30 major reforms across Modi’s tenure, the government has finalized only two significant reforms during the first two years of its third term. The pace is notably slower than during Modi’s first and second terms.
Richard Rossow, Senior Adviser and Chair on India and Emerging Asia Economics at the Center for Strategic and International Studies, said land acquisition procedures and legal dispute resolution mechanisms have not shown measurable improvement. He added that labor regulations have improved only marginally, while access to reliable and reasonably priced electricity and water continues to pose major obstacles to India’s industrialization ambitions.
The government’s recent management of the economy has also attracted growing criticism from economists and policy experts. While some are urging accelerated reforms to address structural weaknesses, others argue that India is falling behind in the global artificial intelligence race.
Last month, economist Surjit Bhalla, a former member of the Prime Minister’s Economic Advisory Council, urged Modi’s political party to use the economic stress created by the Middle East crisis as an opportunity to advance long-pending reforms. However, no major reform measures have been announced so far.
As India navigates rising inflation risks, slowing growth projections, increasing energy costs, and a sharp withdrawal of foreign capital, the coming months are expected to be critical for the government’s reform agenda. The ability to restore investor confidence and address structural economic challenges could play a decisive role in shaping India’s long-term growth story and global investment appeal.
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