Two-time Olympic medallist shuttler P V Sindhu and H S Prannoy advanced to the quarter-finals, but Sania Nehwal's campaign ended at the Yonex-Sunrise India Open, in New Delhi, on Thursday.
Former champion and 2012 Olympics bronze medallist Newhal suffered a 17-21, 9-21 defeat to compatriot Malvika Bansod.
The 20-year-old Bansod, ranked 111th, needed just 34 minutes to see off the former world number 1 and become only the second Indian to defeat the country's badminton icon since 2017 in any international tournament.
Earlier, top seed Sindhu had no problem in dispatching fellow-Indian Ira Sharma 21-10, 21-10.
She will meet compatriot Ashmita Chaliha, who got the better of French shuttler Yaelle Hoyaux 21-17, 21-14 in the quarter-finals.
Bansod will next take on fellow-Indian Aakarshi Kashyap in the quarters.
Aakarshi defeated compatriot Keyura Mopatin 21-10, 21-10 in another women's singles second round match.
"It was my first meeting with Saina Nehwal. She has been my idol since I started playing badminton. So playing against her was a dream come true and that too in the Indian Open, on such a big stage.
"A Super 500 tournament, it was a big achievement for me, one of the biggest wins of my career so far," said Bansod after her victory.
Coming back from knee and groin injuries, Saina, who had won her first round match on Tuesday, was happy with the her movement on the court but said she had a lot of catching up to do on the fitness front.
"I was moving on the court but my fitness is still not where it should be. So I came here to see were I stand.
My body is good but fitness level I need to work on," said Saina, adding that Malvika is "very good" in rallies and has a bright future.
Prannoy received a walkover as his opponent Mithun Manjunath withdrew from the tournament after testing positive for COVID-19.
The men's top seed Kidambi Srikanth, doubles player Ashwini Ponnappa, Ritika Rahul Thkar, Treesa Jolly, Simran Aman Singh and Khushi Gupta are the other players who had to withdraw from the tournament due to the positive COVID-19 results, which led to several walkovers.
Prannoy will meet third seed and World Championships bronze medallist Lakshay Sen, who beat Felix Burestedt of Sweden 21-12, 21-15.
Sameer Verma's campaign also came to an end in the men's singles as he retired midway during his second-round match against Brain Yang of Canada due to calf strain.
In the day's other matches, men's singles World champion Loh Kean Yew defeated Joo Ven Soong 21-12, 21-12 to reach the quarter-finals, where he was also joined by Malaysia's NG Tze Yong.
In the men's doubles, the second seeded pairing of Satwiksairaj Rankireddy and Chirag Shetty defeated compatriots Shyam Prasad and S. Sunjith 21-9, 21-18 in 32minutes.
They will lash with the unseeded duo of Hee Yong Kai Terry and Loh Kean Hean of Singapore.