What's next after India's stock market experiences a record-breaking rally?

This report is from the CNBC "Inside India" newsletter, which provides timely and insightful news and market commentary on the emerging powerhouse and the big businesses driving its rapid growth. If you find it interesting, you can subscribe here.

The big story

Indian stocks reached dizzying heights this week with a record-breaking 14-day rally.

Equities also set six all-time highs within that period.

The enthusiasm for the stock market isn't new, as it has been on the rise throughout the year. In fact, there have been 44 record highs set in this year's 169 trading sessions, according to CNBC's count.

The latest economic data indicates that the South Asian nation's perfect growth story may be at risk, as GDP growth slowed to 6.7% in the second quarter compared to 8.2% in the previous year.

India's near-term economic growth has been downgraded by Bank of America from 7.2% to 6.8% for the current financial year. The Wall Street bank also predicts that GDP will only modestly rise to 7% the following year, which is below the Indian central bank's forecast.

"According to BofA's India economist Rahul Bajoria, the economy is experiencing rising slack, as indicated by low inflation, a small current account deficit, and rapidly consolidating fiscal balances. This is supported by evidence of faltering consumer and business confidence, despite persistent asset price inflation."

The slowdown in economic growth is likely to become a key risk for equities, as it will be the first time since the Covid-19 pandemic and will occur when monetary and fiscal policy is tightening.

The potential shift in government spending from capital expenditure to welfare could pose a risk to domestic politics, as it may reignite inflationary forces and add downward pressure on companies' earnings.

According to Morgan Stanley, a drop of more than 10% from the most recent peak in the equity market could reveal these risks.

The most surprising worry for investors this week should be the stock market's own success.

The MSCI Emerging Markets Investable Market Index now has a higher allocation to Indian stocks at 22.14%, surpassing the 21.5% allocation to China.

"According to Morgan Stanley's Ridham Desai, a rising index weight can indicate optimism, but it could also be due to fundamental factors such as increasing free float and higher relative earnings."

As foreign investors increase their investments in India, they are being outcompeted by domestic systematic fund flows, resulting in rising valuations.

In 2008, China became the largest weighting in the index, but Chinese stocks underperformed the broader emerging market index for the next four years.

"India does not need to adhere to the same model, but the key point is that India is gaining a larger share in global GDP and, as a result, a larger share in the global market. Desai stated that a bull market peak may still be in the future, and India's weight in the emerging market index may need to increase further before it reaches its peak."

Need to know

During his two-day visit to Singapore this week, PM Narendra Modi signed memorandums of understanding for cooperation on semiconductors with the Singapore government. CNBC's Tanvir Gill had the opportunity to discuss key areas of cooperation with Modi.

Future conflicts may arise due to water scarcity, according to an expert. The depletion of water resources should be recognized as a significant environmental security issue of the century. Although not limited to India, there have been concerns that water shortages could harm New Delhi's economic stability and both the Brahmaputra and Indus rivers have been identified as potential flashpoints.

Malcolm Dorson, a senior portfolio manager at Global X ETFs, stated that investors are seeking international investments and their initial destination has been India. He recommended six large-cap stocks to invest in the Indian market.

What happened in the markets?

After a significant surge, Indian stocks are momentarily pausing. The index currently stands at 25,145 points, representing a 0.14% decline this week. Despite this, the index has experienced an impressive 15.65% growth in 2021.

The Indian government bond yield has remained relatively stable at approximately 6.85% over the past 10 years.

This week on Biz Focus Hub, Rana Gupta, the managing director of Indian equities at Manulife Investment Management, talks about the performance and outlook of public sector banks in the country.

Santanu Sengupta of Goldman Sachs suggested that the Reserve Bank of India could "soften its hawkish stance" in its October meeting if food inflation decreases. Meanwhile, Pranjul Bhandari, the chief India economist at HSBC, made her prediction on RBI rate cuts.

What's happening next week?

Baazar Style Retail and Gala Precision Engineering will list on Friday and Monday, respectively.

September 6: U.S. unemployment, Baazar Style Retail IPO

September 9: Gala Precision Engineering IPO

September 11: U.K. GDP, U.S. inflation

September 12: European Central Bank interest rate