The Transformation of India’s Capital Markets

How AI Has Become a Determinant of its Success

The transformation of India’s capital markets now arguably stands as one of the pillars of its international independence and ability to maintain its sovereignty. However, AI and energy developments this year demand another transformation that is at least as radical.

India’s economy and markets have faced significant external pressures over the past year including sharp foreign investment outflows, a trade war with the US, and the oil price shocks and trade disruptions caused by the war in Iran. The rupee has depreciated by c.12%¹, and Indian equities have underperformed global benchmarks, with foreign investors withdrawing c.US$60 billion from Indian equities over the last 12 months². Global capital has reallocated towards the AI boom and large technology and semiconductor supply chain companies is the US and various Asian markets including China, Taiwan and South Korea. In the AI ecosystem, India is seen largely a consumer and service provider, lacking the frontier model capabilities, chip supply chains and sovereign compute infrastructure, and it has thus been a bystander and victim of the market boom.

Yet, India’s macroeconomy has remained remarkably resilient despite this global capital withdrawal, with GDP growing at c.8% GDP in the fiscal year ending 31st March 2026³, faster than any other major economy, and inflation remaining under 4% during the past year⁴ , notwithstanding increased inflationary pressures in recent months due to the war in Iran. This is primarily due to the significant structural deepening of India’s domestic capital markets over the last decade. A series of reforms have led to the financialisation of savings and broadening equity participation, which combined with a matured IPO, alternatives and corporate bond market has helped drive a surge of domestic capital – an unprecedented c.US$100 billion of net domestic institutional inflows into equities over the last 12 months⁵ – mitigating the impact of foreign outflows and external shocks on India’s markets to an extent.

With continued geopolitical uncertainty, India clearly needs continued market and tax reforms to further deepen its domestic capital markets and re-attract foreign investors. However, the scale and nature of the foreign withdrawal suggests that this is more than a cyclical phenomenon that can be fixed by just adjusting incentives. It suggests that India’s value contribution and capture in the age of AI is seen as limited relative to other countries and without fundamental changes and scaled investments in education, training, R&D, semiconductors, and sovereign compute capacity, there is a risk that India remains a bystander and low-value participant in the global AI value chain.

This paper analyses the critical shifts which collectively illustrate the structural deepening of India’s capital markets over the last decade, and the challenges that lie ahead in sustaining this resilience.

Five Shifts Underpinning India’s Capital Markets Transformation

A combination of rapid economic growth – averaging of 7% p.a. over the past decade – and several deep and coordinated policy reform initiatives have brought about a rapid transformation in India’s capital markets. Transformative reforms include the liberalisation of market access and product frameworks by the securities regulator, a financial inclusion initiative which saw nearly 600 million Indians brought into the formal banking system and a rapid shift to digital transactions, a new bankruptcy code which strengthened creditors’ rights, alongside continued fiscal discipline in the face of large external shocks.

These initiatives provide the backdrop for five simultaneous and interlinked capital market shifts outlined below. These shifts collectively signal the rapid expansion of India’s capital markets and its increasing resilience to external shocks.

India’s capital markets have historically been highly dependent on foreign capital, and when foreign institutional investors sold India, both equity markets and the rupee have suffered. Deepening domestic participation has driven a sustained surge of inflows over the last three to five years, with c.US$100bn of domestic capital added over the last 12 months alone, more than offsetting the unprecedented US$60 billion of foreign selling over the same period. A decade ago, foreign investors held more than double domestic institutions’ share of listed equities; that has now reversed.

Implications. Indian corporates are now less dependent on raising capital from abroad and have a deep pool of investors to tap into domestically. The sustained increase in domestic capital mobilisation and resulting increase in overall institutional investment from c.US$10bn to US$40-60bn annually over the last five years suggests this could be a structural shift which creates both a larger and more consistent pool of equity capital.

India’s growth has historically been constrained by its low proportion of household financial savings, with equity participation limited to the urban affluent. Over the last decade, India’s savings have rapidly shifted to financial investments in mutual funds, equities and debt, driven by frictionless digital payments, various apps designed to enable small-scale investor participation, and a push by the asset management industry into tier-2/3 towns. There are now c.200m demat and c.100m systematic investment plan (SIP) account holders, c.8x and 10x higher than a decade ago, indicating genuine broad-based retail investor participation.

Implications. There has been a fundamental change in savings behaviour, with broad-based domestic participation in equities. SIP flows are income-linked and continue through periods of volatility, providing a structural buffer against foreign outflows. The young profile of this new investor base implies a multi-decade savings horizon, implying continued growth ahead.

India's corporate bond market is expanding in both scale and issuer diversity, with total AUM tripling over the last decade and increasing c.7x, from 10% to 17% of GDP, in the last 15 years. There are c.6,700 active bond issuers currently, with several smaller companies and non-AAA rated corporates accessing the debt markets. Bond market growth has been supported by a growing pool of investors domestically and demand for more varied and complex credit investments, which has been effectively mobilised by private credit oriented alternative investment funds (AIFs) and credit oriented mutual funds.

Implications. The investor base participating in India’s bond market is now significantly broader and deeper, allowing a growing number of smaller Indian corporates and non-AAA rated issuers to access the private debt markets. Yes, India’s bond market remains underpenetrated relative to Asian benchmarks, suggesting significant headroom for further growth and the need for continued liberalisation.

A new regulatory framework introduced in 2012 for alternative investment funds (AIFs) has led to the rapid growth of India’s domestic private markets industry with c.1,900 registered AIFs across buyout, growth equity, venture capital, real estate, infrastructure and private credit strategies (vs. 219 a decade ago), managing INR16.9 trillion of total commitments, or 4.7% of GDP. This has helped drive the pace of private equity and venture capital investments from US$19bn in 2015 to US$56bn in 2025.

Implications. India’s alternatives sector has grown and matured, and mobilised demand from a domestic limited partner base at scale much like the rise of Renminbi funds in China two decades ago. This will support continued rapid growth in alternative investment activity and reduce dependence on foreign capital.

India's IPO market has historically been highly cyclical, dependent on foreign investors and concentrated among a narrow set of sectors. This has changed in the last two years, with strong IPO volumes despite muted returns and sustained foreign selling. India’s now accounts for 22% of IPOs globally (by number of issues). In addition, the rise of the SME exchange has allowed smaller companies to tap public markets, with 255 issuances in in FY26, raising INR110bn at an average issue size of c.US$4-5m.

Implications. A more consistent IPO window for private companies underwritten by domestic institutions (vs. the earlier paradigm of opening and shutting based on foreign appetite) provides a more reliable exit path for private investors and an opportunity for companies across both traditional and new age sectors to tap the public markets.

Capital Markets Strength is Hiding India’s Competitive Weakness in AI

The deepening of India’s capital markets is clearly a crucial and positive step in the evolution of its economy and markets. The mobilisation of domestic capital combined with the growing maturity of capital markets to efficiently allocate this capital has strengthened the foundation of India’s growth and made it more resilient from external shocks. However, the prolonged and unprecedented net outflows from foreign institutional investors indicates that this may not just be a cyclical phenomenon but possibly a sign of deeper structural weakness.

Over the last year, global capital has re-allocated towards a sharp rally in artificial intelligence companies. While virtually all major equity markets have demonstrated strong returns, Indian equities have declined, further compounded by a depreciating currency. The global AI rally has exposed India’s relatively weak AI capabilities and the fact that no Indian company is seen as a global leader in the AI value chain. Lacking foundational models and research, adequate compute infrastructure, and semiconductor relevance, India is seen primarily as a large market and hub for low-cost talent for service delivery, a consumer and service provider for AI rather than an IP creator and owner.

These weaknesses are risks not only for its capital markets but also for its real economy. Its ability to capture value as a consumer and service provider is highly limited and exposes it to value extraction by global players. This reality is reflected in the sharp underperformance of India’s IT giants which have declined by c.30% during the past year, even as traditional sectors like pharmaceuticals and automobiles have performed comparatively better (c.14% and c.12% positive returns respectively over the same period)²¹.

The table below illustrates India’s AI capabilities across different areas relative to other major countries and regions based on various external benchmarking studies, alongside the AI market leaders which have attracted capital in the recent global AI rally and the countries overall equity market performance.

Capital market deepening alone will not be enough to insulate India from the AI-driven disruptions that likely lie ahead. India urgently needs to create a supply of scaled, high-quality tech and AI companies, by investing in sovereign AI infrastructure, implementing a credible semiconductor policy (that can build on the foundations of the India Semiconductor Mission) and providing R&D incentives that reward product creation rather than service delivery. Talent development and retention is equally important. India continues to export a disproportionate share of its highest-potential technology founders to Silicon Valley and other developed markets. Otherwise, there is a risk that India remains a consumer and services provider in the AI era, rather than becoming a creator and platform builder, with deep markets but disappointing returns.

Conclusions

Just as the transformation of India’s capital markets was essential for the country to build its sovereignty from foreign capital, it is now essential for India to focus on securing its sovereignty in AI and energy.

The transformation of India’s capital markets started in 1991, when India needed an IMF bailout from an acute balance-of-payments crisis, with the government pledging sovereign gold as collateral. Economic liberalisation followed, largely out of necessity, but the financial sector and capital markets took significantly longer to reform and liberalise. Until five years ago, domestic financial investments were inconsequential, India remained dependent on foreign capital, and external liquidity shocks were amplified. In contrast, last year when global risk appetite contracted and foreign investors withdrew billions from Indian equities, domestic institutions absorbed the outflows and bond markets remained orderly, and the currency depreciated in a gradual manner rather than in a sudden panic. In these 35 years, through successive reforms, India showed that it has built its sovereignty from the inherent uncertainty of global capital flows.

However, this resilience is being stress-tested today. The war in Iran has spotlighted India's energy dependency and compromised merchandise trade routes that pass through the Red Sea and Gulf corridors. A stronger focus on domestic energy production and an acceleration of renewables capacity addition is needed to guard against oil price shocks and ensure energy security. Currency depreciation has tightened the cost of external financing and complicated the current account arithmetic. In this context, continuous reforms are required to continue deepening domestic capital markets while trying to reattract foreign investors.

More worryingly, India’s unprecedented foreign investor outflows contrast sharply to virtually every major equity market in the world that has rallied sharply, surfacing a structural vulnerability in AI that capital market depth alone cannot address; India's ability to participate as a creator, rather than a consumer, in the next technological paradigm remains deeply constrained by compute access, frontier model capability, and a talent ecosystem that continues to export its best minds overseas. This requires urgent actions to address the root causes to ensure that India does not remain a bystander in the age of AI.

India’s capital markets have clearly matured and transformed over the last decade and crossed a threshold of depth, self-sufficiency, and institutional maturity. This has a direct impact on the risk and resilience of India as a market. However, there are now a new set of structural challenges that India's policy agenda must confront, most notably in addressing its competitive weaknesses in AI. The capital market transformation over the last decade provides a strong foundation but does not, by itself, guarantee the outcome.

The Leader: Endnotes

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