What explains the volatility of stock markets in India?


The stock market has become volatile due to unprecedented inflation and the unexpected war in Ukraine.

After a meteoric run in stocks for much of 2020 and most of 2021, the stock market pendulum started to swing back in December 2021. The negative trend started with foreign investors withdrawing funds from Indian markets due to unprecedented levels of inflation in the United States, which was then aggravated by the unexpected war in Ukraine. The two events sent the Indian stock market down 15% from its peak, causing widespread concern among investors.

According to analysts, the market volatility index has reached levels not seen in a decade. “We will probably see one more [interest rate] hike by Reserve Bank of India [RBI], after which the indices stabilize. However, it will be difficult until the end of the year,” an analyst said.

Tracing the movements of the Bombay Stock Exchange (BSE) over the past year shows the fluctuations of the market and the bearing inflation on it. On June 1, 2021, the stock market closed at 51,934.88 Sensex points. It stayed in this range for a few months before starting to rise in September and hitting a year high of 61,765 on October 18. November and December saw strong fluctuations. The market recovered slightly in January 2022, but when the war in Ukraine broke out, it crashed to 53,424.09 in February. It rose to 59,276.69 in April. However, on May 19, the Sensex dropped 1,416.30 points to 52,792.23. The National Stock Exchange (NSE) lost 430.90 points to close at 15,809.40. Both had posted their worst day since February 24, 2022.

A comparison of stock market movements from the above data (table) and RBI inflation rates for the corresponding period shows that markets rose and fell inversely to inflation rates. For example, the inflation rate went from 6.26% in June 2021 to 4.48% in October 2021. The stock market peaked during this period. Similarly, as inflation climbed back to 6.01 in January 2022, the market became volatile, with the stock index falling from 61,223.03 on January 14 to 57,200.23 on January 28. decline in the markets.

Analysts say the erosion of wealth, particularly the impact on the retail investor, is of concern. Over the past decade, stocks have become an attractive destination for individual investors, leading to a significant increase in their participation in stock trading. According to the NSE quarterly report for January 2022, retail ownership has increased steadily, from 8.4% in January 2021 to 9.3% at the end of September. The number of retail investors, according to the NSE, was 20 million in 2012. In December 2020, it was 50 million.

Causes of accidents

The market volatility has been attributed to tight supply chains around the world following the war in Ukraine, which pushed up the prices of wheat and oil commodities. This, in turn, fueled inflation, and the US Federal Reserve and India’s RBI responded by raising interest rates. The surprise announcement by the Indian central bank in May of a 40 basis point interest rate hike further spooked the markets.

Analysts, however, point out that the downturn began long before the war. Data released by Central Depository Services Limited (CDSL), a market infrastructure institution, shows that the withdrawal of Foreign Portfolio Investors (REITs) and Foreign Institutional Investors (FIIs) began in April 2021. In just five months , from January to May 2022, Rs.1,62,299.61 crore was withdrawn by REITs/FIIs, says CSDL. According to NSE data, FIIs/REITs have a 22% presence in Indian markets, second only to Indian developers who own about 32% of Indian stocks.

Inflation has a ripple effect on businesses, which extends to the stock market. Rising interest rates also negatively affect corporate borrowing costs. For example, cement companies, which have a large presence in the market, raise product prices to manage commodity risk, and borrowing costs become a concern. As a result, earnings are expected to come under pressure in the year ahead, affecting the stock prices of these companies, the analyst said.

At its fourth quarter earnings call, infrastructure majors Larsen and Toubro validated what analysts have been saying over the past few months. The company’s management admitted that the volatility in the price of crude oil and other raw materials resulting from geopolitical uncertainties was driving up input prices. The weakening of the rupiah against the dollar will put further pressure on commodity prices, leading to an even bigger decline. “Very few sectors survived the assault. The market has fallen below the danger level. A recovery will probably only be seen in the second half of the year,” said Miten Mehta of Bellwether Finance in Mumbai.

The biggest casualty of the stock market crash is the new technology sector. Companies such as Zomato, Nykaa and PolicyBazaar have recently listed on Indian stock exchanges to much fanfare. (PayTM was the one exception that lost value almost immediately upon listing.) Prices for some of these companies doubled from their initial public offering (IPO) price within months. But following recent events, the share prices of these companies have fallen between 50 and 80% of their peak values.


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