How policy reforms recast FII–DII dynamics in Indian markets

India’s equity markets are often described as volatile, yet their deeper story over the past few years has been one of steady institutionalisation. While global cues continue to influence sentiment, the market’s internal architecture has evolved meaningfully. A major driver of this evolution has been a deliberate policy push, across both the cash and derivatives segments, aimed at transparency, risk containment, and investor protection.

These reforms have coincided with a rapid rise in market depth, a sustained shift of household savings towards financial assets, and a stronger domestic institutional bid that has increasingly offset foreign risk-off flows.

A key marker of this transition is the expansion of India’s mutual fund industry. As of December 2025, the Indian mutual fund industry’s Assets Under Management (AUM) stood at US$922 billion, rising over six-fold in the last decade.¹

This reform-led transformation has therefore reshaped the behavioural balance between Foreign Institutional Investors (FIIs) and Domestic Institutional Investors (DIIs), creating a more resilient market ecosystem. In earlier cycles, heavy FII selling often translated into sharp drawdowns and liquidity stress. 

For instance, in 2025, foreign portfolio investors have been net sellers of Indian equities to the tune of approximately US$18-19 billion.² Today, India’s markets have become better equipped to absorb such shocks, with domestic capital acting as an increasingly dependable counterweight.

Key policy reforms across cash and derivatives markets

India’s regulatory evolution has largely been guided by one principle: participation must grow alongside discipline. SEBI’s recent measures reflect a broader intent to deepen markets without compromising systemic stability.

1. Strengthening corporate governance and disclosure standards³
In the cash market, SEBI has continued to raise disclosure expectations, sharpen scrutiny on related-party transactions, and strengthen compliance standards for listed entities.

For FIIs, such reforms make India’s market structure resemble developed-market frameworks. For DIIs, they build trust in the long-term integrity of listed companies.

2. Market microstructure and risk management reforms
A key pillar of SEBI’s reform agenda has been strengthening market plumbing, including tighter risk management systems, improved surveillance, and enhanced transparency in trade reporting.

The intent is clear: liquidity must be deep, but also clean. Measures aimed at curbing excessive speculation, improving margin discipline, and monitoring market conduct have enhanced the quality of participation.

3. Derivatives Reforms to Reinforce Investor Protection
SEBI’s recent derivatives-focused reforms,⁴ including proposals around position limits, product suitability, and margin structures, are aimed at ensuring that derivatives remain aligned with their core purpose: hedging and risk management.

Budget-linked commentary has also indicated a tilt towards encouraging long-term investing behaviour, reinforcing the broader policy theme that capital markets should support wealth creation rather than short-term gambling.

Impact on volatility, liquidity quality, and systemic stability

The resilience of India’s market structure is increasingly visible in the way domestic institutions absorb the volatility caused by FII exits. In multiple market phases in 2024 and 2025, DII inflows continued even as FIIs reduced exposure, reflecting a structural domestic bid. For instance, India’s mutual fund SIP inflows have remained consistently above US$3 billion per month in FY 2025-26, reinforcing the predictable liquidity base DIIs can deploy into market corrections.

Figure 1 - Month-wise SIP contribution collected from FY 2016-17 onwards⁵

Liquidity quality: Depth with greater discipline

India’s liquidity profile has improved because of a structural domestic capital base, supported by growing mutual fund assets, insurance allocations, and retirement savings. This domestic pool has become a powerful counter-cyclical liquidity source.

Systemic stability: A market less dependent on external cycles

Perhaps the most meaningful outcome of these reforms has been improved systemic resilience, reflected in rising domestic participation over foreign flows. By early 2025, DIIs overtook foreign investors in India’s equity markets, holding 17.62% of equity compared with 17.22% for FPIs. 27.1% of market capitalisation was domestically owned, making markets less dependent on foreign flows.⁶

Figure 2 - Trend of DII growth⁷

Behavioural changes between FIIs and DIIs during volatility and policy transitions

Policy reforms have not only changed the market’s structural stability - they have also influenced investor behaviour. FIIs continue to operate with a global opportunity lens. Their allocations to India are influenced by comparative valuations, earnings momentum, currency stability, and global risk sentiment.

Morgan Stanley’s India equity commentary has highlighted India’s differentiated earnings profile and structural growth advantage relative to many peers, reinforcing why FIIs tend to re-enter India quickly after risk-off phases .

Yet, DIIs have arguably undergone the most profound behavioural shift, with domestic mutual funds, insurance companies, and pension-linked capital becoming structurally stronger over the past decade. 

How policy evolution enabled sustained FII and DII participation

India’s policy trajectory reflects a deeper understanding of capital market development: participation is a function of confidence.

For FIIs, confidence comes from predictability, regulatory stability, and reduced governance risk. SEBI’s reforms around disclosure, surveillance, and risk management have reduced tail risks and strengthened institutional credibility. For DIIs and retail-linked capital, confidence comes from investor protection. Stricter oversight of intermediaries, better compliance enforcement, and clearer rules for product suitability are essential to sustaining long-term participation.

India’s policy reforms are not aimed at restricting participation, but at improving its quality. This is precisely what has enabled sustained FII and DII engagement even during global volatility cycles. India’s growth story, therefore, is increasingly supported not just by macroeconomic strength but by financial market architecture that inspires trust.

Conclusion

India’s capital markets are entering a more mature phase, shaped by policy reforms that prioritise transparency, systemic stability, and investor protection. The impact of these reforms is visible in the evolving relationship between FIIs and DIIs, which signals that India’s market future will not be defined only by how much foreign capital participates, but by how robustly domestic and foreign investors can coexist within a disciplined, well-regulated ecosystem.

In that sense, India’s equity markets are no longer simply responding to policy. They are increasingly being shaped by it, moving from policy intent to participation-led maturity.

1. https://www.amfiindia.com/articles/indian-mutual INR 80,23,379 crore at an assumed exchange rate of INR 87 per USD;

2. https://economictimes.indiatimes.com/markets/stocks/news/at-18-4-billion-fpi-equity-sales-hit-new-record/articleshow/125968517.cms

3. https://knmindia.com/sebis-2025-reforms-what-global-investors-must-know-about-indian-deal-making/

4. https://nsearchives.nseindia.com//web/mediaattachment/2026-01/Market_Pulse_January_2026_FINAL.pdf

5. https://www.amfiindia.com/articles/mutual-fund Assuming exchange rates (INR per USD) are: FY17 – 67; FY18 – 65; FY19 – 68; FY20 – 70; FY21 – 74; FY22 – 74; FY23 – 78; FY24 – 82; FY25 – 84; FY26 – 87

6. https://www.ibef.org/blogs/growing-power-of-india-s-diis

7. https://www.ibef.org/blogs/growing-power-of-india-s-diis