It's a lot more about global liquidity these days, which keeps driving stock prices higher and less about economic and corporate fundamentals. Since the Federal Reserve announced its asset purchase programme or QE3 a lot of liquidity has been unleashed into the global financial system. A lot of this finds has found its way into stock markets and other asset classes like gold. In the first few months of 2013, India was the largest recipient of foreign fund inflow in Asia outside of Japan, spurred by easing measures like QE3.
The Fed has been buying $85 billion in treasuries and mortgage-backed securities each month as part of the QE3 plan. With economic recovery in the US gathering steam this asset purchase programme maybe tapered off as early as September. This means that global liquidity will reduce, and foreign fund flow into the Indian stock markets will be lower.
This is what spooked Indian markets on Friday. Investors worried that a tapering off of QE3 and complete withdrawal of the same would mean foreign funds would pull out of India. This is why stocks in which foreign funds have major holdings like HDFC, HDFC Bank and ITC collapsed in trade.
QE3 tapering and subsequent withdrawal will also have a cascading effect on the rupee on account of reduced foreign inflow into the Indian markets.
In any case, the US Federal Reserve will take a decision on whether to taper its bond buying programme in the month of September. Until then, Indian markets can brace for some volatility.