For the first time since at least 2000, no Indian company ranked among the top 10 on the MSCI Emerging Markets Index, the index that determines how hundreds of billions of dollars are allocated to developing economies around the world.
The index’s two largest constituents in India – HDFC Bank and Reliance Industries – have fallen to 11th and 12th places in recent months, from seventh and eighth places in March. The weight of each of them decreased to less than 0.8% of the index. India’s overall weight fell to 10.87% – its lowest level in six years, and nearly half the record level reached in 2024, when the country briefly emerged as the largest component of a sub-index, the MSCI Emerging Markets Index, before China regained its position.
Behind it is a shift in capital markets towards artificial intelligence and technology stocks.
Why is the standard weight not just a number?
The MSCI EM Index serves as instruction for a significant portion of global institutional capital. Passive funds — exchange-traded funds and index funds whose investment mandates require them to mirror the index — manage more than $700 billion in assets measured by the MSCI Emerging Markets Index, according to a Business Standard report.
MSCI data shows that total assets measured by MSCI Emerging Markets indexes, including active funds that measure their performance against the same index, exceed $1.8 trillion.
When a country’s weight falls, passive funds – under their investment mandates, at scheduled quarterly rebalancing events – are required to reduce their holdings proportionately. The decision was not because the fund manager decided that India was a bad bet, but because the formula said so.
The impact on actively managed funds is less mechanical but equally important.
An active fund manager who wants to hold a smaller amount of India than the index dictates is making a deliberate, responsible bet — and must defend it to clients. As India’s weight falls, the cost of this bet shrinks. It becomes easier for a country to be underweight without it appearing to be a tangible deviation from the norm.
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The second pressure falls on a stressful external account
The downgrade in India’s index comes in conjunction with separate pressure on domestic capital markets.
Mutual fund inflows fell by 40% on a monthly basis to $229.08 billion ($2.4 billion) in May – the lowest level in a year – as volatility linked to the Iran war kept domestic investors cautious, according to data from the Mutual Fund Association of India. Flows to small, medium and large funds decreased by 28%, 33% and 37%, respectively.
AMFI CEO Venkat Chalasani told Reuters that the price of crude oil hovering around $100 per barrel is the immediate reason for investors’ decline. The rising prices have raised market volatility high enough that local investors have pulled out of stocks across the board.
But the same shock carries a second consequence. India, the world’s third-largest oil importer, is extremely vulnerable: High crude oil prices inflate the import bill, widen the current account deficit (the gap between what a country earns from abroad and what it spends), and squeeze the margin of foreign exchange reserves.
Reserve pressure was evident in other policy moves. In May, the government raised customs duties on gold and silver imports to 15% from 6%. Prime Minister Narendra Modi has made an unusual public appeal to Indians to avoid buying gold for a year. Both measures were aimed at relieving pressure on foreign exchange reserves. Gold exchange-traded funds later recorded outflows from $7.25 billion – a record.
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What did the government do in response?
As these pressures mounted, the government announced a package of foreign investment reforms on June 5. The measures included a decree exempting foreign portfolio investors from income tax on interest and capital gains on government securities, expanding the categories of bonds accessible to foreign investors to include new long-term and green bond issues, and a soft foreign currency deposit window under which the Reserve Bank of India would bear the entire hedging cost of banks raising deposits abroad – a facility targeting about $20 billion, according to people familiar with the matter.
The reforms are also timed to impact an impending review by Bloomberg Index Services of India’s potential inclusion in its leading global aggregate index — an index largely tracked by institutional investors in developed markets, HT reported last week.
Bloomberg postponed India’s accession in January, citing gaps in its tax processing workflow and settlement infrastructure. Analysts estimate that inclusion could generate negative flows of about $25 billion.
It is not yet known whether the June package will resolve Bloomberg’s outstanding concerns. The January postponement identified automated trading workflow and settlement infrastructure as barriers — issues that differ from the tax question addressed by the decree. This determination, expected around mid-year, will go some way toward answering how large the capital account gap the government can realistically close.
