Foreign institutional investors (FIIs) have withdrawn $21 billion from Indian markets since the beginning of 2025, prompting equity strategists to look toward the Union Budget as a potential catalyst for reversing this trend. Morgan Stanley's Ridham Desai, who leads the firm's India equity strategy team, has identified three specific capital market reforms that could meaningfully address the FII outflow challenge.

Three Key Reform Areas

Desai outlined the potential reforms in a Budget strategy note, emphasizing their importance in addressing foreign portfolio investor concerns:

"There has been growing concern about the negative balance of payments and foreign portfolio investor (FPI) selling. In this context, it is quite possible that the Budget proposes broadening the base of foreign portfolio investors, allowing more pools of capital to access Indian stocks," Desai stated.

GIFT City Development Strategy

The enhancement of GIFT City represents a significant opportunity for India to compete with established international financial centers. As global financial flows increasingly route through such centers, GIFT City remains underdeveloped compared to peers like Singapore and Hong Kong. By strengthening tax incentives and regulatory frameworks, the government could attract more foreign capital into Indian securities through platforms such as the Gateway International Exchange.

This development would create additional avenues for FII participation, particularly benefiting investors facing regulatory or structural constraints in traditional market-access mechanisms.

Current Market Outflow Situation

The foreign investment landscape presents concerning trends for Indian markets:

Budget Expectations and Market Positioning

Desai's team expects the Budget to focus on several key areas that could support market recovery. "It appears the market is expecting modest fiscal consolidation to protect growth, flat to higher capital spending as a percentage of GDP, and some additional tax incentives for manufacturing," he noted.

The Budget is likely to emphasize deficit reduction, government capital expenditure, the debt calendar, and capital market reforms specifically aimed at boosting foreign inflows. Morgan Stanley maintains an overweight stance on Financials, Consumer Discretionary, and Industrials sectors, which would likely serve as primary beneficiaries if FII flows return.

Historical Budget Performance Analysis

Morgan Stanley's analysis reveals important patterns in market behavior around Budget announcements. India is currently tracking lower on both absolute and relative bases heading into the budget. Historical data shows that when equity markets have fallen in the 30 days preceding the Budget announcement, the probability of a post-budget rally increases meaningfully.

Conversely, the market has historically fallen on two of three occasions in the 30 days following the budget. This probability rises to 75% if the market has risen in the 30 days preceding the budget. Only on three occasions in 32 years has the market been up both before and after the budget, with the most recent occurrence in 2024.

"This year, India is tracking lower on both an absolute and relative basis, and if it were to hold this performance into the budget day, the chances of a post-budget rally increase," the global brokerage concluded.

As Union Budget 2026 approaches, corporate India is signaling a fundamental shift in priorities. Rather than seeking broad fiscal stimulus or headline tax reductions, industry leaders across sectors are increasingly focused on execution efficiency—specifically addressing approval delays, regulatory overlaps, and policy mismatches that create hidden costs throughout the economy.

Housing Sector Takes Center Stage

The housing sector has emerged as one of the most significant themes in pre-budget discussions, reflecting its substantial multiplier effect on employment, consumption, and infrastructure development. Despite resilient residential demand, particularly in mid-income and premium segments, industry participants highlight persistent policy framework challenges.

Parveen Jain, President of NAREDCO, emphasizes that the absence of full industry and infrastructure status for real estate continues limiting access to long-term capital, even as the sector expands into rental housing and mixed-use developments. Akshay Taneja, CEO of TDI Infrastructure, and Ashish Narain Agarwal, Founder & Managing Director of PropertyPistol, note that affordability-linked incentives lose relevance when policy thresholds fail to reflect actual land, construction, and compliance costs in metropolitan areas.

Tier-2 and Tier-3 Cities Drive Growth

Unlike previous cycles dominated by metropolitan areas, the current housing upcycle is increasingly driven by Tier-2 and Tier-3 cities and peripheral urban corridors. Infrastructure investments in expressways, airports, metro rail, and industrial nodes are reshaping demand patterns across emerging centers including Noida, Gurugram's outer belts, Sonipat, and Hyderabad.

Rohit Kishore, CEO of Hero Realty, highlights how infrastructure projects such as the Noida International Airport and expressway connectivity are driving end-user demand, supported by corporate inflows, data centers, and manufacturing units. Abhay Mishra, President & CEO of Jindal Realty, similarly identifies Tier-II cities as the new growth engine for housing, contingent on sustained urban infrastructure spending.

Manufacturing and MSME Challenges

India's manufacturing sector continues facing significant cost-of-entry barriers, with MSMEs particularly affected by fragmented industrial land availability, duplicated infrastructure, and prolonged approval processes. Yogesh Bhatia, Managing Director & CEO of LML Realty, indicates that reducing factory setup costs by even 15.00–25.00 percent could significantly improve manufacturing viability and formal employment, especially in Tier-2 and Tier-3 cities.

Digital and AI Sector Requirements

As artificial intelligence and data-driven platforms transition from experimentation to core business infrastructure, industry expectations are shifting toward scale-ready policy frameworks. Akshay Chhabra, Chairman & Managing Director of 1Point1 Solutions, and Anand Bhadkamkar, Group CFO of LS Digital, emphasize the need for research and development incentives, data governance clarity, and domestic digital ecosystem support to enable AI-led productivity gains.

In the Global Capability Center space, Lalit Ahuja, Founder & CEO of ANSR, stresses that predictable tax and GST treatment—particularly for cross-border services, intellectual property creation, and R&D activities—remains essential to sustain India's competitiveness as a global capability hub.

Startup Ecosystem Seeks Stability

For startups and investors, the emphasis has shifted firmly toward procedural certainty rather than new scheme proliferation. Rathnakar Samavedam, Investment Director & Managing Partner of Hyderabad Angles Fund, argues that unresolved legacy angel tax disputes and delayed loss recognition continue weighing on investor confidence.

Early-stage founders highlight cash-flow stress from delayed GST input credit and TDS refunds, particularly affecting companies with extended research and development cycles. The startup community is prioritizing resolution of existing procedural bottlenecks over introduction of additional support mechanisms.

Emerging Sectors and Long-term Capacity Building

Beyond traditional sectors, long-term capacity building has gained prominence across education, climate markets, and emerging asset classes. In education, sustained investment in research infrastructure and doctoral funding aligned with NEP 2020 is viewed as critical for positioning India as a global knowledge hub.

Climate markets present unique opportunities, with industry leaders emphasizing the need for robust registries, measurement systems, and digital trust layers as core financial infrastructure to ensure transparency and global acceptance as India transitions to compliance-driven carbon markets.

The consistent message across sectors—from dairy and hospitality to retail technology and luxury housing—reflects a mature approach to policy expectations. Industry is not seeking aggressive fiscal expansion but rather updated policy assumptions, faster execution, and regulatory coherence that reduce hidden costs and unlock long-term capital deployment.