These factors coincided with the weekly Nifty expiry, which takes place every Thursday and tends to be volatile.

The benchmark Nifty and Sensex logged their biggest decline in two months of over 2% as foreign institutional investors sold a single- day record ₹15,243.27 crore worth of shares in the secondary market, per BSE data. Volatility could continue on persistent FII outflows in the short term.

Nifty tanked by 2.12% to 25,250.10 points and Sensex by 2.1% to 82497.10.

Domestic institutional investors (DIIs) purchased a provisional ₹12,913.96 crore on Thursday, per exchange data, but that wasn’t enough to stave off the market plunge as retail clients trading directly could have also sold shares. That data wasn’t immediately available.

Investor nervousness was reflected by fear gauge India Vix surging 9.86% to close at 13.17, the biggest jump in two months. A rise in Vix implies greater uncertainty while a fall suggests confidence.

Hot money to China

Rate-sensitive sectors were the biggest casualties of Thursday’s bloodbath, with Nifty Realty tumbling 4.36%, Nifty Auto falling 2.88%, and the Nifty Private Bank and Bank Nifty shedding 2.61% and 2%, respectively.

In terms of stocks, the biggest drags on bellwether Nifty were Reliance Industries Ltd, which lost 87.37 points, followed by HDFC Bank Ltd (-76.36), Larsen & Toubro Ltd (-38.8), Axis Bank Ltd (30.88), and ICICI Bank Ltd (-25.97). These five stocks alone contributed almost half of Nifty’s loss of 547 points.

While a large part of the investments by foreign portfolio and institutional investors (FPIs and FIIs) are long-term and stable, short-term flows, called hot money, can turn at the drop of a hat, said analysts.

“Part of the negative impact on flows in stocks and on an incremental basis is that of hot money getting diverted to China from India,” said Sanjeev Prasad, managing director and co-head of Kotak Institutional Equities. “Outflows, especially from the secondary market, have been pretty high in the past two days.”

While the Fed’s steeper-than-expected rate cut last month would have normally resulted in inflows to emerging markets, Beijing’s monetary stimuli have encouraged flows to China at the cost of nations like India, said Andrew Holland, chief executive of Avendus Capital Public Markets Alternate Strategies.

Also, stronger crude results in India importing inflation, which weakens the rupee, and consequently dollar returns for foreign investors, he added.

“Hot money outflows are likely from India to China in the short-term, but domestic money can absorb the selling over time,” said A. Balasubramanian, MD and CEO of Aditya Birla Sun Life AMC, about the FII provisional sell figure.

Israel’s impact on RBI rate cut

Rising crude, analysts fear, could force the Reserve Bank of India to hold its key policy rate—at which RBI lends to banks—longer than expected, even as the US Federal Reserve looks set to cut its interest rates by another 50 basis points this year. 

Crude oil has risen by 5% since Tuesday, when Iran launched 180 ballistic missiles at Israel. On Thursday noon, crude was at $75.5 per barrel on fears that Israel might strike Iranian oil and gas rigs in retaliation as the country takes its battle beyond Palestine and the militant group Hamas.

While China’s plan for a trillion-dollar stimulus this year to prevent a long-drawn slowdown has resulted in the diversion of fund flows from emerging markets like India, the escalation of tensions in West Asia this week could prevent RBI from following the Fed’s example of cutting rates to spur growth, said experts.

Net outflows by foreign portfolio investors (FPI) from India have totalled ₹11,635.42 crore so far in October, per depository data. Had it not been for their ₹3,395 crore investments in primary markets over the two days (2 October was a market holiday on account of Gandhi Jayanti), the sell figure would have been higher, the data show. In the calendar year so far, FPI net investment stands at ₹88,975 crore.

“The MPC (Monetary Policy Committee), which was expected to cut the repo rate at its December meeting, would wait to see the impact of inflation, which will increase in the event of a full-blown Israel-Iran conflict,” said Holland of Avendus Capital.

MPC meets on 7-9 October and 4-6 December this year.

Derivatives outflows

Rohit Srivastava, founder of IndiaCharts, expects FIIs to have reduced their bullish bets on index futures and index call options on Thursday, which could have exacerbated the fall despite DIIs putting up stiff resistance.

While data for this wasn’t immediately available on NSE, FIIs held a net long position of 318,317 index futures contracts (Nifty and Bank Nifty) and net long of 631,596 index call options on 1 October, per exchange data.

Srivastava expects the market to respect the technical support of 25,226, but if this is breaks out it could test 24,454, he added.

Pricey valuations

The FII selling coincides with high valuations in India, especially of the broader markets than large caps. While Nifty trades at a price-to-earnings multiple of 25.23 times versus its historical average of 24.76 times, Nifty Midcap 150 trades at 47.5 times (verses its historical average of 36.15 times) and Nifty Smallcap 250 at 35.9 times (versus 28.79 times).