India’s growth story faces its toughest test yet in Modi’s third term

In his 12th year as Prime Minister, Narendra Modi continues to be popular in India — but the world’s fastest-growing major economy is no longer so popular among global investors.

India’s growing reputation as an anti-artificial intelligence trade, combined with the economic strain of the prolonged conflict in the Middle East on the Indian economy, is leading to a record exodus of foreign investors from the country, experts said.

“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. While it “remains strong by global standards,” the economy is facing headwinds from weaker consumption, fragile investment sentiment, higher energy costs and more selective global capital, she added.

Foreign portfolio investors have sold Indian equities worth $29.5 billion so far this year, after selling $18.9 billion last year.  

On the foreign direct investment front, India has attracted gross capital of over $90 billion on a 12-month trailing basis ending January 2026, up 13% year on year. But this was eclipsed by higher repatriation of capital by foreign firms and a rise in overseas investment by Indian companies, taking net FDI to a “near all-time low.”

This has significantly weakened the Indian rupee against the dollar at a time when global oil prices are rising, creating a treacherous situation for India, which imports more 85% of its crude requirements. 

As the shocks from the Middle East crisis get passed on to consumers, inflation is set to rise while growth is expected to slow, further narrowing India’s appeal among global investors. Last Friday, the Reserve Bank raised its inflation forecast to 5.1% for the financial year ending March 2027 and warned that the economy is likely to grow at a slower rate of 6.6%, from a forecast of 6.9% earlier.

To stem the flow of capital, the Indian government issued a slew of measures last Friday, including exempting capital gains tax for foreign investors in the Indian bond market. While these reforms are timely, India needs to move ahead with big reforms to draw global investors, experts said.

“I think it helps the mood music, but it doesn’t change the symphony,” Stephen Davies, chief executive and founder of Javelin Wealth Management, told CNBC’s Inside India on Tuesday. “We need to see a bit more in terms of a bit more market-friendly policies coming through,” Davis added.

According to the CSIS India reforms scorecard, which measures the progress of 30 big reforms across all of Modi’s terms, the government has finalized only two reforms across the last two years — the start of the third term — a much slower pace than in Modi’s first or second terms. 

“Land acquisition processes and legal remediation of disputes have not measurably…