India Policy Volatility, Capital Formation and Foreign Capital Flows

I’ve been travelling across India this year, and wherever I go, two topics keep coming up: the exodus of foreign investors from Indian markets and the slide in the rupee. I’ve written before about the geopolitics behind much of it: the closure of the Strait of Hormuz, the Houthi escalation, the intensifying Russia–Ukraine war. Throw in rising bond yields and the AI boom, a once-in-a-century technology shift that is pulling capital towards it like a magnet, and money has no shortage of reasons to leave.

There’s another factor that gets much less airtime, though: how often India has changed its policies over the past few years. It isn’t the main driver. I do think it has added to the short-term flight of capital. My argument is simple. When the rules keep changing, it works like a higher discount rate. Investors who can’t predict the rules on tax, moving money, securities, ownership, trade or compliance want to be paid more for the risk. That alone can pull valuations down before a single rupee of expected cash flow goes missing.

Why does it matter more now? When rates were low and the world was calm, India was the golden boy. Investors poured money in on the back of fast growth, a young population and a reputation for strong governance. That gave the government room to try out clever tax and regulatory ideas, and most investors shrugged and went along.

But the cycle has turned. Scrutiny is sharper, valuations look stretched, and AI now threatens many businesses. Take Indian IT and outsourcing. It was one of the big winners of the last cycle, and its high salaries helped create a whole consumer class. That foundation is now on shaky ground. With the ground moving this fast, a tax and regulatory playbook that keeps changing is much harder to justify.

I’m not claiming India’s regulation has got worse every year. The evidence doesn’t say that. What it does show is that the rulebook has become unusually busy in specific areas: financial markets, tax, trade, private capital and cross-border rules. And volatility isn’t the same thing as burden. A tax cut, a deregulation or a repeal all add to volatility, even as they lighten the load. Investors care less about how heavy the rules are than about how hard they are to predict.

You can see this in the money flows, though different kinds of capital behave very differently, depending on how easily they can leave and how long they planned to stay. Foreign investors in listed shares moved fastest and hardest, selling roughly $32.66bn of Indian equities by 28 October 2026, already more than 2025’s record full-year total.

Private capital is a more mixed story. Deals where private investors buy into listed companies (PIPEs) and lending by private funds have dropped sharply. Venture capital and buyouts are down. Growth funds are holding up, and long-term foreign direct investment (FDI) has largely stayed put. It doesn’t look like a mass exit from India. It looks more like a ladder, where the shorter the money’s time horizon, the sooner it heads for the door.

Capital can price a high tax. What it struggles to price is a tax system whose function itself keeps changing.

Policy Volatility as a Higher Discount Rate

Start with what investors want. Whenever they put money into a company, a factory or a stock, they expect a certain return. That expected return is made up of a few building blocks:

This piece is about that last item. When the rules keep changing, investors ask for a little more return to make up for the uncertainty. The catch is that even if a company’s profits don’t budge, a higher required return means investors will pay less for it today.

A quick example. Imagine an investment that pays you ₹100 every year, forever. If you want a 10% return, you’d pay ₹1,000 for it. If policy uncertainty makes you want 12% instead, you’d only pay about ₹833. Roughly 17% of the value has gone, and the ₹100 a year hasn’t changed at all.

There’s also a slower effect. When the rules are unclear, businesses tend to hold off on big, hard-to-reverse investments like building a new plant. Waiting starts to look like the safer choice:

So shifting rules hurt twice. Investors pay less for the same profits today, and over time there are fewer profits to pay for.

What the Evidence Says About India

India’s own government has made the same argument. The 2018–19 Economic Survey argued that policy uncertainty makes investing riskier, raises the cost of money for businesses and can slow down investment. The IMF found something similar when it looked at Indian projects: when policy uncertainty goes up, companies announce fewer new projects and stall, shelve or abandon more of the ones they have.

None of this means India’s institutions are falling apart. In many ways, starting a company has got easier. The trouble starts later. Raise serious money from professional investors, bring in foreign backers, or fall under the rules for funds, foreign exchange and ownership disclosure, and the paperwork piles up fast.

The Tax Rulebook That Keeps Changing

Four Ways the Tax Rules Keep Shifting

Rate volatility: The same tax keeps going up and down. The best example is the tax on futures and options trades, which the government raised in 2024 and again in 2026.

Tax-base volatility: What gets taxed keeps changing: gains on debt funds, share buybacks, dividends, and money raised by startups (the so-called angel tax).

Classification volatility: Investors have to work out which tax bucket their investment or deal falls into, and that isn’t always obvious.

Administrative volatility: The government announces rules, then delays, tweaks or partly rolls them back. Everyone pays for the confusion in lawyers, accountants and lost time before the final version settles.

A high tax and a risky tax are different things. Investors can live with a tax that’s high but stable. What they struggle with is a tax that keeps changing shape.

The Hidden Cost of Raising Private Money

For private companies, the picture is mixed. Setting up a company is now easier, thanks to a single online form (SPICe+). But once professional investors come in, the paperwork piles up: proving who owns what, getting shares valued, anti-money-laundering checks, moving shares into electronic form, custody, audits and reports.

Size matters a lot here. These costs are roughly fixed, so they bite much harder on a ₹100 crore first-time VC fund than on a ₹2,000 crore PE fund, and on a ₹5 crore seed round than on a ₹500 crore deal. Over time, that tilts the field towards bigger funds and bigger deals. One way to measure the drag is to ask how much of every rupee raised goes on getting the deal done:

Delay costs money too. If a startup spends ₹2 crore a month, every extra month spent closing a funding round eats ₹2 crore of its cash, even though no invoice will ever call it a regulatory cost.

How the Rules Pile Up as a Company Grows

In India, starting a company keeps getting easier. Raising serious money for it keeps getting more expensive.

Measuring the Churn: A Volatility Index for India

To track all this, I built a simple scorecard: the Policy & Regulatory Volatility Index (PRVI). It measures how much the economic rulebook is shifting, not whether any single policy is good or bad.

Each big rule change gets five scores out of 10. How big is it (M)? How much money and activity does it touch (B)? How much of a surprise was it (S)? Does it undo an earlier rule (R)? How much extra paperwork does it create (C)? The five scores are then combined into one number. Size counts most (30%), reach and surprise next (20% each), and reversals and paperwork least (15% each). Here’s the formula:

Four Related Measures

PRVI — Policy & Regulatory Volatility Index: How much the rulebook is changing.

PBI — Policy Burden Index: Whether, on balance, the changes are tightening or loosening the rules.

PCI — Policy Complexity Index: How much extra paperwork is being added.

RRI — Regulatory Reversal Index: How often rules are being reversed or reworked.

Dark blue marks the 2023–24 peak; orange is 2026 so far (to 27 October), driven by new RBI and SEBI rules. Source: author’s PRVI event coding.

Once every change is scored, the picture isn’t a steady climb. It comes in waves: a busy 2018–20, a calmer 2021–22, a sharp jump in 2023–24, and a fresh spike in 2026, mostly in financial markets and cross-border money.

Early Tests: Do Rule Changes Line Up With Investment?

A word of caution first: with only nine years of data, we can’t prove cause and effect. These are simple early checks of whether things move together. Several point the way you’d expect. But the sample is small and a lot else was going on, so treat them with caution.

How to read the table: each row compares the index with one type of investment, year by year since 2018. The middle number is a correlation, which runs from −1 to +1. A minus sign means the two move in opposite directions: in busy rule years, that investment was lower. A plus sign means they rise and fall together. The closer the number is to −1 or +1, the stronger the link. Near zero means little connection. As a rough guide, around 0.2 is weak, 0.4–0.5 is moderate and above 0.7 is strong.

What the numbers suggest: foreign direct investment (−0.38) and foreign stakes in Indian companies (−0.48) both tend to be lower in busy rule years. That makes sense. Long-term investors don’t want to commit to a factory when they can’t predict the rules for the next ten years. Private equity and venture capital (−0.19) show only a faint link. That fits the idea that these funds react later, and that global fundraising and how easy it is to cash out matter more to them.

The strongest result is the extra return investors demand for Indian shares (+0.54). When the rules are busier, investors want a bigger reward for holding Indian shares. That is the higher-discount-rate effect from the start of this piece. Finally, company spending on plants and equipment (−0.42) tends to fall the year after a busy rule year. That matches the ‘wait and see’ effect: firms hold off on big, hard-to-reverse projects until the dust settles.

One caveat: with so few years of data, a single unusual year, like the 2020 pandemic shock, can swing the numbers a lot.

One result goes the other way: in some years, more rule changes came alongside more new-project announcements. That’s because the government was also busy handing out support at the same time: production-linked incentives (PLI), subsidies and infrastructure spending. So any proper test has to separate policies that help investors from policies that just keep changing.

Foreign Investors Are Selling Indian Shares

The clearest sign so far is foreign investors selling Indian shares on the stock market. By 28 October 2026 they had sold about $32.66bn this year — well above the roughly $18.91bn they pulled out in the whole of 2025. March 2026 alone saw about $12.14bn of selling, though that month was dominated by the oil and geopolitical shock.

There’s rarely just one reason, of course. The 2026 selling also reflects falling share valuations, higher US bond yields, a strong dollar, a weak rupee, oil, cuts to profit forecasts, and how India stacks up against other emerging markets. Shifting rules are one factor worth testing, not the whole story.

Private Funds: It Depends on the Type of Deal

So private money isn’t simply running away. Growth funds, which buy stakes in fast-growing firms, invested a bit more. But PIPE deals (private investors buying into listed companies) and private credit (loans from funds rather than banks) collapsed, and venture capital and buyouts slowed. That looks like investors being picky about where they put their money, not turning their backs on India.

Fast Money Leaves First

The table shows a simple idea: the easier it is to get your money out, the faster you leave when a country starts to feel riskier. Think of it like guests at a party. The ones standing by the door leave first; the ones who’ve bought a house next door stay put.

So when the rules start shifting, foreign investors in Indian shares should react almost at once. They can sell with one click. PIPE deals and private credit should follow within a quarter or two. Venture capital and private equity, whose money is tied up for years, should react six months to a year and a half later. Foreign companies that have built factories and businesses in India (FDI) should move last, if at all, perhaps one to three years on.

The line below shows that same order, where t is today and t+1, t+2 and so on are the quarters (three-month periods) that follow:

How Stock-Market Selling Spills Into Private Deals

Public and private markets are linked. Private investors usually cash out by listing a company or selling shares on the stock market, so share prices decide what their investments are worth. EY reports that selling on the stock market was still a major way for private funds to cash out in the first half of 2026.

Step by step, it works like this. It starts with foreign investors selling Indian shares, which pushes share prices down. That makes cashing out less rewarding. A company listing on the stock market (an IPO) fetches less, and so does a stake sold to another investor. Private equity funds make smaller profits when they sell, so their returns (what the industry calls IRR) fall. Knowing they’ll get less when they sell, funds offer less for new deals, which pushes down the value of private companies. With lower expected returns and harder fundraising, they invest less, and more slowly. Put simply, a weak stock market today turns into weaker private investment a few quarters later.

If the data shows these steps happening one after another, that would be far stronger evidence than just comparing yearly private-fund totals with the index.

What We Can and Can’t Say Yet

Where does that leave us? A few things are clear. India has changed its rules often, and in ways that matter, across tax, financial markets, trade, company paperwork and cross-border money. 2023–24 saw an unusual pile-up of changes all at once, and 2026 has brought a fresh burst from the RBI and SEBI. Foreign selling of Indian shares has been unusually heavy. Private investors have reacted in different ways, depending on the type of deal and how easy it is to get out. And there’s a well-documented way uncertainty hurts investment: companies demand higher returns, delay projects and pay more to raise money.

Plenty isn’t proven yet, though. I can’t show that shifting rules caused the 2025–26 foreign selling or the slowdown in private investment. Nor is every rule change bad; several of the biggest loosened, simplified or fixed earlier rules. And I can’t yet say India changes its rules more than similar countries do; that would need a proper comparison with other countries.

The bigger point still stands, I think. The problem isn’t that India has ‘too much regulation’. It’s that investors increasingly can’t predict how the rules will change: what the tax rate will be, what gets taxed, which bucket a deal falls into, and how the rules will be applied. What matters is how predictable the rules are. Even a well-run government can put investors off if they can’t tell how the rules on their money will change.

The money flows already hint at this. Foreign money that can leave quickly has reacted hardest, private funds are being choosier, and long-term investment in real businesses is mostly staying put. If proper statistical tests confirm that order, it would tie shifting rules directly back to where this piece began: investors demanding a higher return when the rules are hard to predict.

The next step is to test this with a quarter-by-quarter dataset for 2014 to 2026, combining the index, foreign share flows, new, stalled and finished projects (from CMIE), private fund deals by type, FDI, interest rates, oil, exchange rates, valuations and profit forecasts. Until then, my message to policymakers is short: in a world where capital has plenty of other places to go, a stable rulebook is one of the cheapest ways to keep it.

In practice, that means three things. Announce tax and market changes well in advance. Phase them in rather than switching overnight. And don’t reverse them within a year or two.