Interrelationship between inflation and foreign capital flow For the below let's assume domestic currency is ₹ and foreign capital is in \$

Foreign Capital Inflow => ₹ Appreciates (Because of more \$)

But consider this,

Foreign Capital Inflow => More ₹ in circulation (Since \$ have to be exchanged into ₹ before actually using in India) => More Inflation => ₹  Depreciation

What is wrong in this second reasoning?
I think the flaw in your reasoning is expecting that foreign capital inflow would lead to more ₹ in circulation.  When investors bring in capital, they are buying ₹ that were previously in circulation.  This additional demand without additional supply is exactly what drives the price of the ₹ up.  There is no increase in the quantity of ₹ circulating unless the government/central bank responds in some way.