On 4th May 2023, HDFC reported a strong financial performance with a 20% increase in net profit and a 16% increase in net interest income on a year-on-year basis. Additionally, the company declared a dividend of Rs. 44 per share. This news was well-received by investors, as the share gained 2.6% the same day and the share of HDFC Bank was also up 2.5%. But the next day, on 5th May 2023, the share prices of both HDFC and HDFC Bank were down 6%. What caused this sudden fall in share prices?

The fall in share prices came after American research and investment firm Morgan Stanley Capital International (MSCI) which designs its own indices decided to keep the price adjustment factor for HDFC Bank at 0.5X, as opposed to market expectations of 1X in both the MSCI India Index and the MSCI Emerging Markets Index.

Now, you might wonder ‘What is the adjustment factor?’ and ‘Why is the MSCI Index important?’

The answer to the first question is that the adjustment factor represents the significance of a stock in an index. A higher adjustment factor increases the weightage of a stock in the index, while a lower adjustment factor decreases the weightage of a stock in the index.

And the answer to your second question is that the MSCI Index is tracked by global investors including passive fund managers while investing in emerging economies like India, China, Brazil, etc. Therefore, an increase in the weightage of a particular stock in the Index will lead to inflow of funds and a decrease in the weightage of a particular stock will lead to an outflow of funds in the stock.

Therefore, had the adjustment factor been 1X, HDFC Bank’s weight was expected to be 6.75% and 0.93% in the MSCI India Index and the MSCI Emerging Markets Index respectively. This would have led to an expected inflow of $3 billion. However, with the actual adjustment factor at 0.5X, HDFC Bank’s weight is expected to be 6.50%, and 0.90% in the MSCI India Index and the MSCI Emerging Markets Index respectively. This is expected to cause an outflow of $150 to $200 million. As a result, we saw a fall in the share prices yesterday.

In conclusion, even after HDFC reporting strong financials, the sudden fall in share prices of HDFC and HDFC Bank on the next day was due to MSCI's decision to lower the price adjustment factor for HDFC Bank at 0.5X instead of 1X, leading to an expected lower weightage in the indices and expected outflow of funds.