Over the past two decades, India has established itself as one of the world’s fastest-growing major economies. Strong economic growth, a vast consumer market, a young demographic profile, and the stability of a democratic system have made India an attractive destination for global investors. However, in recent years, several concerning economic signals have begun to emerge. The participation of Foreign Institutional Investors (FIIs) in Indian markets has weakened, the Indian rupee continues to face persistent pressure, and banks are finding it increasingly difficult to attract adequate deposits.
These developments are not isolated events; rather, they represent different dimensions of a larger structural transformation taking place within the Indian economy. The commonly cited explanations for foreign investors reducing their exposure to India—such as a strengthening US dollar, geopolitical uncertainties, or changes in global interest rates—are only part of the story. The recent outperformance of stock markets in Taiwan and South Korea relative to India has also been cited as a contributing factor. While these considerations are important, understanding the complete picture requires examining the changing global flow of capital.
Today, Artificial Intelligence (AI) is no longer merely a technological revolution; it has become a critical driver of economic power, industrial leadership, and investment attraction. Global investors are no longer focused solely on economies that are growing rapidly. Increasingly, they prefer to invest in countries that control the technologies shaping the future.
This explains why Taiwan, South Korea, and the United States have attracted a significant share of global capital in recent years. Taiwan has achieved near-global dominance in the semiconductor industry and plays a pivotal role in manufacturing the advanced chips essential for AI applications. South Korea has established leadership in memory chips and advanced electronics, while the United States continues to dominate AI models, cloud computing, software platforms, and cutting-edge research.
India, by contrast, is not lacking in talented engineers or researchers. However, its economic development in technology has largely been centred around providing services rather than creating foundational technologies. Indian IT companies have achieved remarkable global success, but they primarily serve clients rather than develop globally dominant AI models, semiconductor technologies, or core technology platforms.
Many researchers of Indian origin occupy leadership positions in some of the world’s foremost AI companies. Yet the economic benefits arising from their innovations, intellectual property, and research largely accrue to other nations. This situation stems from several structural factors, including inadequate investment in long-term research, the absence of a robust semiconductor manufacturing ecosystem, limited availability of high-risk venture capital, and insufficient collaboration between research institutions and industry.
Global investors increasingly favour countries that are not merely users of AI technology but owners of it. Although India is rapidly adopting AI across sectors, it still has considerable ground to cover in terms of ownership of technology, research capabilities, and the development of globally competitive AI products. Consequently, a portion of global investment capital appears to be shifting toward countries such as Taiwan, South Korea, and the United States.
Technology, however, is only one part of the equation. Tax policy also plays a significant role. In India, long-term capital gains on listed shares are taxed at 12.5 percent, while short-term gains attract a tax rate of 20 percent. In contrast, several Asian financial centres—including Singapore, Hong Kong, and Taiwan—either impose no tax or very low taxes on capital gains from listed securities. South Korea also provides substantial relief to many retail investors on such gains.
This does not imply that foreign investors are leaving India solely because of taxation. However, when global capital has multiple investment destinations to choose from, tax differentials do affect a country’s competitiveness. Unfortunately, this aspect has not received sufficient attention in policy discussions. Investors ultimately evaluate post-tax returns, and taxation directly influences those returns.
One of the most visible consequences of slowing foreign capital inflows is the pressure exerted on the Indian rupee. When the supply of foreign currency declines, the rupee naturally weakens. Currency depreciation is not merely a concern for foreign exchange markets; it affects the broader economy in multiple ways.
India imports a substantial portion of its crude oil requirements. A weaker rupee makes oil imports more expensive, which in turn increases transportation costs, raises industrial production expenses, and fuels inflation. The cost of imported electronics, industrial machinery, fertilizers, and other essential goods also rises. Indian students pursuing education abroad face higher expenses, while companies with foreign currency borrowings experience an increase in their debt obligations. Government expenditure on subsidies related to fuel, fertilizers, and energy may also rise.
Another important consequence of rupee depreciation is its impact on foreign investors’ returns. Even if investors earn profits in Indian markets, a weaker rupee can reduce the value of those gains when converted into dollars. This may discourage fresh investment, creating a vicious cycle in which declining capital inflows and currency weakness reinforce each other.
At the same time, India has witnessed another significant shift. Household savings are increasingly moving away from traditional bank deposits and towards mutual funds and equity markets. The growth of the Systematic Investment Plan (SIP) culture has created a new investment movement across the country. This trend has strengthened the resilience of Indian equity markets. In the past, heavy selling by FIIs often led to sharp market declines. Today, domestic investors are able to absorb a substantial portion of such shocks.
However, this development also has a less-discussed consequence. Funds that would traditionally have been deposited with banks are now increasingly flowing into equity markets. As a result, deposit growth in banks is lagging behind credit growth. Banks are compelled to offer higher interest rates to attract deposits, increasing their cost of funds. Higher funding costs ultimately translate into higher lending rates.
Small and medium enterprises (SMEs) are particularly affected because they generally do not have access to equity markets as an alternative source of capital. The tax structure may also be contributing to this trend. Interest income from bank deposits is fully taxable, whereas long-term capital gains are taxed at comparatively lower rates. This naturally encourages savers to allocate a greater share of their funds toward equities.
While this shift is positive for capital markets, it may create challenges for the banking sector in the long run.
India’s real challenge today is not merely to attract foreign investors but to enhance its competitiveness in the global contest for capital. Achieving this objective requires a more balanced tax framework, stronger incentives for long-term research, substantial investments in semiconductor manufacturing and AI technologies, deeper collaboration between universities and industry, and greater stability in the rupee.
India possesses enormous strengths—a vast domestic market, exceptional human capital, and immense growth potential. Yet the global competition of the twenty-first century is no longer defined solely by economic growth. It is increasingly driven by technological leadership, research capabilities, innovation ownership, and capital attraction.
If India successfully transitions from a service-oriented technology economy to one driven by research, innovation, and advanced manufacturing, it can emerge as the next major destination for global investment. Otherwise, international capital will continue to gravitate toward more attractive alternatives, with long-term consequences for the rupee, investment levels, and economic growth.
Author Bio
