Morgan Stanley downgraded the rating of India's stock market, with foreign investors withdrawing $1.3 billion in two days, and oil risks becoming the trigger.

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Morgan Stanley downgraded Indian stocks to equal weight with Asia and emerging markets, citing crude oil supply risks triggered by Middle East conflicts as a key catalyst; foreign investors sold a net $1.3 billion in just two trading days, delivering another heavy blow to the Indian stock market.

Citing India’s high vulnerability to oil supply disruptions, Morgan Stanley downgraded Indian stocks’ rating relative to Asia and emerging markets to "equal-weight". After a rebound on Thursday, the Nifty Index turned weak again. This week, Asian regional stock indices are collectively approaching their worst weekly performance in six years.

Oil prices have risen 16% in the past week, while the Indian rupee continues to slide. As an economy highly dependent on crude oil imports, India faces multiple risks including rising inflation, widening current account deficits, and fiscal pressures. The energy shock has become the key variable influencing market sentiment.

According to Bloomberg, citing data from India's Clearing Corporation, in the past 10 trading days, under the “others” category, total purchases of Indian government bonds reached 695 billion rupees, with more than half happening on Wednesday and Thursday. Market participants believe this includes central bank funds, possibly aimed at suppressing rising bond yields caused by inflation.

Oil Shock: Supply Disruptions Put India in a Dilemma

The impact of Middle East conflicts on India's energy supplies is expanding. According to the Financial Times, India’s largest natural gas importer, Petronet LNG, has issued a force majeure notice to supplier Qatar Energy because vessels cannot enter the port to load cargo.

About 40% of India’s natural gas supply comes from Qatar. Petronet’s main clients include GAIL and Indian Oil Corporation, which provide gas to a wide range of businesses and retail users.

On the oil side, India's oil minister said this week that India’s reserves of crude oil and refined products are sufficient to deal with temporary supply constraints, and government sources said the reserves could last about 50 days.

However, the real dilemma is the direction of future crude oil purchases. After months of reducing Russian oil imports, India now faces a difficult choice: resuming purchases of Russian oil could anger the Trump administration and hurt diplomatic ties with Washington; but waiting for an improvement in the Middle East situation poses real energy security risks.

Valuations Still High, Foreign Capital Exodus Adds to Pressure

Before this shock, valuation issues in the Indian stock market had already made institutional investors cautious. The Indian stock market has lagged its Asian peers for more than a year, fundamentally due to slowing corporate earnings growth. The sudden rise in oil prices has further undermined market confidence just as earnings showed signs of recovery, perpetuating the underperformance.

Pratik Gupta, CEO of Kotak Institutional Equities, said there were clear divergences and cautious sentiment at the investor conference held last week. He noted that brokers prefer Nifty 50 constituents but maintain a conservative stance on small- and mid-cap stocks, believing valuations have not yet fallen to sufficiently attractive levels.

Some institutions see localized overselling in the market. JM Financial said that Reliance Industries, India’s largest listed company by market capitalization, has seen its share price drop more than 11% this year, mainly because foreign investors sold their most liquid holdings, and views this decline as excessive.

Central Bank Acts on Two Fronts, Stabilizes Currency and Bond Market

On the policy front, the bond market is receiving more “implicit support”. Bloomberg, citing data from India's Clearing Corporation, reported that in the past 10 trading days, under the “others” category, total purchases of Indian government bonds reached 695 billion rupees, with more than half occurring on Wednesday and Thursday, which market participants believe includes central bank funds.

Bloomberg reported that this move may be intended to suppress bond yields driven higher by oil-induced inflation and fiscal deficit concerns, while offsetting the liquidity drain from the central bank’s recent interventions in the currency market.

Key Technical Support Emerges, but Sustainability Uncertain

Although fundamental pressures have not dissipated, on Thursday the Nifty Index demonstrated a noteworthy technical signal. The index found support and stabilized near its 100-week moving average, posting its largest single-day gain in over a month.

Historically, this moving average has served as a long-term support level for Indian stocks during periods of stress, with the only clear break occurring during the global market panic of the 2020 pandemic. Historical data shows that rebounds from this area typically see staged gains of 5% to 10% for the Nifty.

However, whether this technical signal can evolve into a sustained rebound will depend on how the Middle East situation and oil prices develop next. On Friday, Asian regional indices fell again, and this week’s overall performance is approaching the worst weekly record in six years.

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