Foreign investors bought Indian equities worth $3.1 billion in August, the highest monthly inflow since they bought shares worth $6.9 billion in September 2024. This was the second straight month of foreign buying after a four-month selloff.The renewed interest, following $2.1 billion of foreign investment in Indian equities in July, has been driven by reasonable valuations, better-than-expected earnings for the April-June quarter, relatively stable macroeconomic conditions and a shift away from AI-heavy markets in recent months.Reasonable valuations in the Indian stock market are among the biggest drivers of the revival, especially after one of the worst four-month stretches in years, when foreign investors sold Indian equities worth $27.8 billion between March and June. The benchmark Nifty 50 and Sensex had declined around 5% during that period, weighed down by the conflict in West Asia and the AI-led rally in global markets.In comparison, both indices are up around 1% since July. Broader mid- and small-cap indices have also gained 5-6% over the same period, suggesting that investors are finding opportunities across a wider range of the market.These reasonable valuations, coupled with higher-than-expected earnings growth in Q1FY27, have provided foreign investors with an opportunity to buy Indian equities even as they continued selling stocks in the AI-heavy South Korean market through August.The Reserve Bank of India also kept the key interest rate steady earlier this month, even as the minutes indicated rate hikes going ahead as inflation is expected to rise over FY27. While a rate hike by itself is not necessarily a positive or negative reason, the prolonged pause eases uncertainty at a time when valuations in several pockets of the Indian market are reasonable after months of continuous selling.“Foreign investors turned buyers in August largely because the RBI kept policy stable while valuations had already absorbed months of selling pressure,” noted a report from Maxiom Wealth last week.Story continues below this adA rate hike in itself is not a positive catalyst for foreign investors, but it can ease uncertainty at a time when valuations in several pockets of the Indian market have become more reasonable after months of sustained selling.“Interestingly, this pattern has shown up before in Indian markets: heavy, sustained outflows tend to exhaust themselves once valuations catch down to global risk appetite, at which point even a modest improvement in the macro picture is enough to draw a portion of the capital back in. That appears to be closer to what happened in early August than any single dramatic catalyst,” the report noted.Also Read | 3 reasons why GDP growth overshot expectations, and why India’s ‘resilience’ comes amid lingering risksFinancial services, auto among FIIs’ top picksThe financial services sector attracted the strongest interest, with FIIs buying $685 million worth of shares in the sector during the first half of August, according to data from the National Securities Depository Limited. The automobile sector saw an inflow of $462 million during the period. Consumer services, healthcare and IT also saw robust inflows of between $200 million and $400 million.Barring financial services, all these sectors had recorded positive inflows in the previous 15 days.Story continues below this adWhile data for the second half of the month has not yet been released, most of these sectors have continued to perform well. Healthcare gained around 1.2% in August, while IT and auto rose up to 1%. Financial services gained as much as 1.6% in early August before giving up some of those gains.Foreign flows to remain volatileDespite the strong revival over the past two months, most market experts see the buying as temporary and opportunistic rather than the beginning of a structural revival. Foreign inflows are therefore expected to remain volatile and dependent on factors such as crude oil prices, geopolitical stability and taxation.“It is not a structural reversal, as buying value is insignificant compared to their selling in the last 2 years…structural buying can happen if peace prevails in West Asia, and therefore, oil prices fall more than 20% from current levels,” said G Chokkalingam, founder of Equinomix Research.“This inflow should be seen as an opportunistic bet by FIIs. Flows into India coincided with the global AI rally beginning to crack. Plus, earnings and other such factors boosted the mood. But a lot now depends on how all that plays out,” the equity head at a domestic broking firm said.Story continues below this adMany market participants also believe that FIIs are unlikely to turn structurally positive on Indian equities unless taxation is eased.“In our view, capital gains tax (CGT) on FPIs in India should go, because we feel it is doing more harm than good. It has created friction, caused double taxation, and a 2.4 percentage-point CAGR hit on post-tax returns for FPIs,” noted an IIFL Capital report earlier this month.India currently levies both securities transaction tax (STT) and capital gains tax and is among the few major markets globally to charge STT on FPIs. While many market participants, and in some cases bureaucrats, have acknowledged that removing STT would make the Indian market more attractive to FIIs, the final decision rests with the Finance Ministry.