India’s surging mutual fund SIP culture may be quietly tightening the noose around the rupee, by giving foreign investors a smooth exit route from the expensive equity market, Jefferies has argued in a new strategy note.In a report decoding the pressure on the Indian rupee and "the downside of SIPs", Jefferies argues that the current bout of rupee weakness has little to do with the usual villain, the current account deficit (CAD), and almost everything to do with a collapse in capital flows driven by equity market outflows.“Not CAD but all-time low capital flows is the culprit for INR pressure,” Jefferies analyst Mahesh Nandurkar said, pointing out that India’s CAD has averaged just 0.8% of GDP over FY24–26, the lowest ever, and is projected to remain contained at about 2% of GDP in FY27 even after assuming crude at 90 dollars a barrel and a decline in gold imports.What has changed, Jefferies contends, is the behaviour of foreign capital. Over FY25–26, equity-market-driven foreign outflows added up to a massive $78 billion, with foreign institutional investors (FIIs), private equity funds and foreign promoters all using the deep domestic bid to cash out. “Strong domestic flows (strong MF flows thanks to SIPs and tax advantage for equity investments, higher equity allocation by EPFO and NPS) continue to absorb heavy foreign selling in equity markets,” the report noted.Also Read | The 20 stocks mutual funds are buying with Rs 1 lakh crore to defy historic FII sellingHow SIP money is funding foreign outflowsAccording to Jefferies, the structural rise in domestic savings into equities via mutual fund SIPs, EPFO, and NPS has effectively created an “easy exit” mechanism for global investors looking to rotate out of India, which the brokerage describes as an “expensive market”.FPIs alone have sold a net $44 billion dollars of Indian equity since April 2024, while net FDI has dwindled as foreign promoters and PEs stepped up stake sales, pulling net FDI down to about 5 billion dollars over FY25–26. As a result, the capital account surplus has shrunk to just around 0.5% of GDP over FY25–26, compared with a 2.6% average surplus over the previous decade – the lowest level on record.This drain has been powerful enough to tip the overall balance of payments into the red for two consecutive years, with Jefferies expecting another negative BoP year ahead. The brokerage’s FY27 balance-of-payments snapshot pegs the trade deficit at $334 billion (8.5% of GDP), a CAD of $36 billion (0.9% of GDP) and a modest $25 billion capital account surplus, translating into a BoP deficit of $11 billion in FY26 and a larger shortfall in FY27.“Capital account weakness is the key concern,” Jefferies said, highlighting that domestic equity flows are effectively financing record foreign equity outflows even as macro fundamentals on the current account side remain relatively healthy.Also Read | FIIs slash allocation in India's top 10 bluechip stocks by half. Is that a warning sign for your portfolio?Record-low capital flows, record-high FPI sellingJefferies’ data underscore how extreme the foreign selling has become. Net FPI outflows from Indian equities were a record $21 billion in FY26 and remain negative in FY27 so far. On a trailing 12-month basis, FPI equity outflows have hit a 20-year low of minus $31 billion, and on a trailing 18‑month basis, the cumulative sell-off is an even steeper 40 billion dollars.At the same time, the much-hyped bond index inclusion trade has already played out, with FPI inflows into debt moderating after a strong FY24, Jefferies pointed out. Net debt flows are now only marginally positive.FDI is not picking up the slack either. While gross inbound FDI is expected to rise to $100 billion in FY27, higher outbound FDI and repatriation-related outflows have sharply eroded the net number. Net FDI flows have collapsed from the mid‑40 billion dollar range in FY21–22 to just about $5 billion in FY26 and are projected to improve only slightly to $9 billion in FY27.“Higher outbound FDI, along with repatriation-related outflows, has been a key factor weighing on net FDI inflows,” the brokerage observed.Rupee undervalued, but history offers some hopeDespite this squeeze from the capital account, Jefferies does not see the rupee in free fall. RBI’s foreign exchange reserves stand at $597 billion after adjusting for roughly $100 billion of forward shorts, providing about nine months of import cover – below the historical average, but still “substantial” by the firm’s estimate.On a real effective exchange rate (REER) basis, the rupee looks significantly undervalued. India’s 40‑currency trade-weighted REER has dropped by about 14% since December 2024 to an estimated 91, a 12‑year low. “REER at c.91 (INR 9% undervalued) provides comfort and historically (barring GFC), INR has rebounded from such levels,” Jefferies said.The divergence from global currency moves has been stark. Since January 2024, the rupee has been one of the worst performers among major emerging market currencies, even though the dollar index has been largely flat. Jefferies’ chart shows INR depreciating by about 14% against the dollar since May 2025, while the DXY hovered in a narrow band.Looking back at past episodes of sharp rupee depreciation — defined as more than 10% fall in 12 months — the brokerage notes that FPI flows have typically seen a “remarkable upsurge” in the subsequent year in three out of four instances. However, a weaker rupee has not consistently translated into a meaningful export boost, especially outside oil and electronics.What govt, Mint Street, can still doSo far, policy responses have largely been limited to “moral suasion” to curb foreign exchange outflows — from work‑from‑home advisories to reduce travel and oil use, to nudges on discretionary imports. But Jefferies believes tougher measures cannot be ruled out if capital flows fail to revive.“Stricter policy choices (e.g. lower LRS limits, quantitative import restrictions, higher custom duties etc.), further increase in retail fuel prices (to suppress oil import demand) are possible,” the report said. The government could also pivot to boosting capital inflows by cutting FPI taxes on debt and equity, offering targeted incentives for NRI deposits, or further liberalising external commercial borrowings, although replicating the 2013‑style FCNR schemes may be harder now as the interest rate gap between the rupee and the dollar has narrowed.Jefferies also flags the risk from India’s tight linkages with the Middle East, which accounts for 17% of exports and 38% of remittances, cautioning that any prolonged regional disruption could dampen the current account. On the positive side, net services exports – led by IT and other business services, including global capability centres (GCCs) – surged 14–15% in FY26 to 217 billion dollars, covering around 65% of the merchandise trade deficit.For SIP investors: comfort and a hard truthFor the millions of Indians diligently investing via SIPs, the Jefferies note delivers a mixed message. On one hand, domestic flows have been a powerful stabiliser for the equity market, cushioning stock prices against record foreign selling. On the other hand, that very stability has allowed foreign capital to exit in size without crashing valuations, pushing the rupee lower via the capital account.In Jefferies’ base case, the rupee is expected to recover somewhat to 93–95 per dollar over the next 12 months, assuming the Strait of Hormuz reopens, and the ongoing unwinding of the global AI trade eases FPI outflows. “The same can happen again if AI as the dominant global investment theme slows down,” the brokerage said, referring to past episodes where a sharp INR slide was followed by a strong rebound in foreign equity flows.(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)