For the first time at least since 2000, no Indian company features in the top 10 of the MSCI Emerging Markets Index, a benchmark that determines how hundreds of billions of dollars are allocated to developing economies around the world.
India’s two biggest constituents in the index – HDFC Bank and Reliance Industries – have slipped to 11th and 12th position in recent months, from 7th and 8th in March. Their individual weighting has fallen below 0.8% of the index. India’s total weighting fell to 10.87% – a six-year low, and about half the record level in 2024, when the country briefly emerged as the largest component of an offshoot index, the MSCI EM Investable Market Index, before China reclaimed the position.
Behind this is the shift towards artificial intelligence and technology stocks in the capital markets.
Why isn’t the benchmark weight just a number?
The MSCI EM Index serves as an index for a significant portion of global institutional capital. Passive funds – exchange-traded funds and index funds whose investments require them to reflect an index – manage more than $700 billion in assets benchmarked to MSCI EM, Business Standard reports.
MSCI data shows that total assets benchmarked on MSCI emerging markets indices, which also include active funds that measure their performance against the same benchmarks, exceed $1.8 trillion.
When a country’s weighting falls, passive funds are required – in accordance with their investment mandates, in scheduled quarterly rebalancing programs – to reduce their stake proportionately. The decision is not because a fund manager decided India was a bad bet, but because a source said so.
The effect on actively managed funds is less mechanical but equally consequential.
An active fund manager who wants to hold India below the range set by the index is making a deliberate, accountable bet – and he must defend it to clients. As India’s weight falls, the value of that bet goes down. It becomes easier to give a country less weight without it appearing as a meaningful deviation from the benchmark.
Also read: Tackling weaknesses in India’s supply chain resilience
Second pressure on stressed external account
The de-ranking of India’s index comes with a distinct pressure on domestic capital markets.
Equity mutual fund inflows fell 40% month-on-month ₹₹229.08 billion ($2.4 billion) in May – the lowest in a year – as volatility linked to the Iran war kept domestic investors cautious, according to data from the Association of Mutual Funds in India. Inflows into small-, mid- and large-cap funds fell 28%, 33% and 37% respectively.
AMFI Chief Executive Venkat Chalasani told Reuters that crude oil reaching around $100 a barrel was the direct reason for investors’ withdrawal. The price rise increased market volatility so much that domestic investors pulled out of equities across the board.
But the same shock also brings another consequence. India, the world’s third-largest oil importer, is badly exposed: higher crude prices push up the import bill, increase the current account deficit (the difference between what a country earns from abroad and what it spends) and reduce margins on foreign exchange reserves.
Reserve pressure is visible in other policy steps. In May, the government increased the import duty on gold and silver from 6% to 15%. Prime Minister Narendra Modi made an unusual public appeal to Indians to avoid buying gold for a year. Both these measures were aimed at reducing pressure on foreign exchange reserves. Later outflows from gold exchange-traded funds were recorded ₹7.25 billion – a record.
Also read: The world’s great powers are learning they have limits
What has the government done in response
As these pressures increased, the government announced a package of foreign investment reforms on 5 June. These measures include an ordinance exempting foreign portfolio investors from income tax on interest and capital gains from government securities, an expansion of bond categories accessible to foreign investors for the issuance of new long-term and green bonds, and a concessional foreign currency deposit window under which the Reserve Bank of India will bear the entire hedging cost for banks raising foreign deposits – a facility targeted at about $20 billion, according to people aware of the matter.
The reforms were also timed to influence the impending review by Bloomberg Index Services of India’s possible inclusion in its flagship Global Aggregate Index – a benchmark heavily tracked by developed-market institutional investors, HT reported last week.
Bloomberg postponed entry into India in January, citing gaps in tax-processing workflow and settlement infrastructure. Analysts estimate that the inclusion could generate passive inflows of around $25 billion.
Whether the June package will address Bloomberg’s outstanding concerns is not yet known. The January moratorium named automated trading workflows and settlement infrastructure as hurdles – separate issues from the tax question addressed by the ordinance. This determination, expected in the middle of the year, will go some way towards answering how much of the capital account gap the government can realistically close.
