The war in the Middle East has kept commodity prices highly volatile since the first quarter of 2026. It is the latest in a series of major shocks to the global economy, and Indian equities have felt the strain. Yet, India has buffers. Its longer-term resilience rests on structural themes including physical AI, electronics and defence manufacturing and a power grid buildout.
A Losing Run
After briefly touching record levels in early 2026, the Sensex and Nifty 50 posted eight straight weekly losses through early October. It was the longest such run since 2001. The streak ended in the week of October 5, but markets have stayed volatile. The week ending October 24 was another losing one, with heightened crude prices and foreign investors selling.
Over the past two years, foreign institutional investors have pulled out nearly $40bn, according to Bernstein Research. Much of that money has moved to stronger-performing markets, particularly Korea and Taiwan. These countries are benefitting from the optimism around long-term prospects of AI.
As foreign outflows widened, domestic institutions and retail investors became the market’s main support. Mutual funds have played a central role, cushioning the fall. Mutual fund assets under management have grown from about $125 billion in 2016 to nearly $900 billion this year. Parallelly, the number of Indians investing in stocks and mutual funds has more than tripled to 150 million.
However, this makes the recent fall more concerning. Households are already dealing with a weak job market, high inflation and faltering consumption. Now their equity savings are taking a beating too.
Why The Market Slid?
Five pressures explain the slump—
- Inflation. Energy prices remain under pressure from the Middle East conflict. The shock has spread to fertiliser and metals, raising input costs for businesses.
- Interest Rates. Global interest rates have risen with the US 10-year yield hovering near the 5% threshold. This makes the US debt more attractive for investors. A higher risk-free return also means expensive equity markets are hit the hardest.
- Rupee Depreciation. A weaker Rupee further deepens the losses of investors making investments abroad more attractive.
- Valuations. Indian stocks have become cheaper, but they are still relatively expensive. The premium Indian equities have long commanded over other Asian markets has shrunk, because earnings growth now looks less impressive than elsewhere in the region. Expected earnings growth is just 7% for 2027 and 11% for 2028, at a forward P/E of 18.4x, according to JP Morgan.
- The missing AI piece. India has yet to experience the full lift of the AI boom that has powered other Asian markets. Investors are also weighing how AI will reshape labour outsourcing businesses, such as call centres and IT consulting.
India Still Has Buffers
Despite these pressures, India has room to absorb the shock. Foreign exchange reserves were stood at $734.6 billion in the beginning of October, roughly 11 months of import cover. Domestic institutions have matured with record net inflow of ₹8.5 lakh crore in FY26, which cushions the impact of foreign selling. And the RBI projects growth of 7.1% for 2026-27.
Upbeat Primary Market
Even as the broader market stumbled, India’s primary market had its busiest month of the year in September, with a record 34 mainboard IPOs raising nearly ₹39,380 crore. Steady demand for new listings suggests domestic investors still have an appetite for equities.
The Currency Intervention
The Rupee depreciated by 1.4% against the US dollar in H1:2026-27. Consequently, the RBI stepped in to support the currency. It sold dollars from its reserves, opened a special window to supply dollars to oil companies and set reserve requirements for large hedge positions.
In October, the Rupee bounced back from its earlier decline, climbing to a six-week high on October 20, before reversing gains.
Along with the RBI’s intervention, India has also moved to attract foreign-exchange inflows. In June, it cut taxes on foreign investment in government debt and raised $143 billion through a dollar deposit scheme aimed at the Indian diaspora.
Strong Banking Fundamentals
Indian banks are navigating the shock from a position of strength. The sector is witnessing its strongest balance sheet positions in decades, backed by multi-decade low non-performing assets (NPAs) and solid capital buffers. RBI’s stress tests confirm the resilience of the financial systems.
Keeping Policy Predictable
Foreign investors look beyond headline tax rates. They weigh macro stability, regulation, how comfortable they are repatriating funds and how predictable policy is. India can meet all four concerns by providing a stable policy. Steady rules tell investors what to expect and that matters more to them than a lower tax rate.
Stepping Into The AI Value Chain
India has a deep listed ecosystem tied to the next phase of AI spending, including power, data centres, electrical equipment and capital goods. It needs to capitalise on this ecosystem to enhance long-term appeal to investors.
The Longer Game
Broadening the horizon a little further, India has several long-term moves to consider.
Deepening Capital Markets
India’s market has leaned on domestic savers, mainly through mutual funds, as foreign money has left. A deeper market, with a wider base of long-term investors and more ways to raise capital, would make India less dependent on foreign flows and less exposed to their swings.
Reducing Import Dependence
Managing imported commodity price pressures well will be central to macroeconomic stability in the period ahead. To this end, the tools available are the use of strategic petroleum reserves, import diversification and targeted fiscal support. India has already widened its crude oil sourcing from 27 countries to 41, and its LNG sourcing from six countries to fifteen. Structural import dependence, however, will take decades to change.
Surviving The Shock, then Outgrowing It
India’s capital market is under pressure, but it is not short of defences. Reserves, domestic investment and strong banks have limited the damage so far. They buy time. They do not eliminate the risks. Energy prices, elevated rates, a weaker rupee and modest earnings growth will keep testing the market.
What happens next depends on choices. Predictable policy would give foreign investors confidence. Deeper capital markets would reduce reliance on them. A bigger role in the AI value chain would improve India’s long-term appeal. The near term will stay uncertain. The longer term is India’s to shape.
