For the first time, the effect of microscale shear stress induced by both mechanical compression and ball-milling on the phase stability of nanocrystalline tetragonal zirconia (t-ZrO2) powders was studied in water free, inert atmosphere. It was found that nanocrystalline t-ZrO2 powders are extremely sensitive to both macroscopic uniaxial compressive strain and ball-milling induced shear stress and easily transform martensitically into the monoclinic phase. A linear relationship between applied compressive stress and the degree of tetragonal to monoclinic (t → m) phase transformation was observed. Ball-milling induced microscale stress has a similar effect on the t → m phase transformation. Furthermore, it was found that even very mild milling condition, such as 120 rpm, 1 h (0.5 mm balls) was enough to induce phase transformation. Surfactant assisted ball-milling was found to be very effective in de-agglomeration of our nanocrystalline porous ZrO2 particles into discrete nanocrystals. However, the t → m phase transformation could not be avoided totally even at very mild milling condition. This suggests that the metastable t-ZrO2 is extreme sensitive to microscale shear stress induced by both mechanical compression and ball-milling. The findings presented in this work are very important in further understanding the stress-induced phase transformation of nanocrystalline t-ZrO2 powders in a water free atmosphere and their further stabilization in industrially relevant solvents.