India falls out of EM index top 10 for first time in 26 years—What that means & why it matters

FOr the number one clip since at to the lowest degree 2000, no native american keep company ranks in the top 10 of the MSCI Emerging Markets Index, a benchmark that shapes how hundreds of billions of dollars are allocated to developing economies worldwide.India's two largest constituents in the index — HDFC Bank and Reliance Industries — slipped to 11th and 12th positions in recent months, from 7th and 8th in March. Their individual weightings have each fallen below 0.8% of the index. India's overall weight dropped to 10.87% — a six-year low, and roughly half the record level reached in 2024, when the country had briefly emerged as the largest component of an offshoot index, the MSCI EM Investable Market Index, before China reclaimed the position.Behind it is a shift in capital markets towards artificial intelligence and technology stocks.Why a benchmark weight is not just a numberThe MSCI EM index functions as an 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 benchmarked to MSCI EM, according to a Business Standard report.Total assets benchmarked to MSCI's emerging market indexes, including active funds that measure their performance against the same benchmark, exceed $1.8 trillion, MSCI data shows.When a country's weight falls, passive funds are required — by their investment mandates, at scheduled quarterly rebalancing events — to reduce their holdings proportionally. The decision is not because a fund manager decided India was a bad bet, it's because a formula said so.The effect on actively managed funds is less mechanical but equally consequential.An active fund manager who wants to hold less India than the index dictates is making a deliberate, accountable bet — and must defend it to clients. As India's weight falls, the cost of that bet shrinks. The country becomes easier to underweight without it appearing as a meaningful divergence from the benchmark.Also read: Tackling vulnerabilities in India's supply chain resilienceSecond pressure landing on a stressed external accountIndia's index de-ranking arrives alongside a separate squeeze on domestic capital markets.Equity mutual fund inflows fell 40% month-on-month to ₹229.08 billion ($2.4 billion) in May — their lowest in a year — as volatility tied 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.Crude oil hovering around $100 a barrel is the direct cause of the investor retreat, AMFI chief executive Venkat Chalasani told Reuters. The price spike pushed market volatility high enough that domestic investors have pulled back from equities across the board.But the same shock carries a second consequence. India, the world's third-largest oil importer, is acutely exposed: elevated crude prices inflate the import bill, widen the current account deficit (gap between what a country earns from abroad and what it spends) and compress the margin on foreign exchange reserves.Reserve pressure has been visible in other policy moves. In May, the government raised import tariffs on gold and silver to 15% from 6%. Prime Minister Narendra Modi made an unusual public appeal for Indians to avoid gold purchases for a year. Both of these were measures aimed at easing pressure on forex reserves. Gold exchange-traded funds subsequently recorded outflows of ₹7.25 billion — a record.Also read: The world’s great powers are learning they have limitsWhat government has done in responseAs these pressures mounted, the government announced a package of foreign investment reforms on June 5. The measures included 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 to include new long-dated and green bond issuances, and a concessional foreign currency deposit window under which the Reserve Bank of India would bear the full hedging cost for banks raising overseas deposits — a facility targeting approximately $20 billion, according to people aware of the matter.The reforms were also timed to influence an imminent review by Bloomberg Index Services of India's potential inclusion in its flagship Global Aggregate Index — a benchmark tracked heavily by developed-market institutional investors, HT reported last week.Bloomberg deferred India's entry in January, citing gaps in tax-processing workflows and settlement infrastructure. Inclusion could generate passive inflows of approximately $25 billion, analysts have estimated.Whether the June package resolves Bloomberg's outstanding concerns is not yet known. The January deferral named automated trading workflows and settlement infrastructure as barriers — issues distinct from the tax question the ordinance addresses. That determination, expected around mid-year, will go some way toward answering how much of the capital account gap the government can realistically close.