On edge: on the volatility in Indian markets

Mains Paper: 3 | Economy 
Prelims level: Non-banking financial companies
Mains level: The panic sell-off raises the alarm about risks that face the Indian markets

Context

Volatility is back in the Indian markets. 

• Stock indices witnessed an extraordinary swing on Friday, with the Sensex moving 1,500 points between its high and low during the day and the Nifty almost by 370 points. 
• The Sensex and the Nifty were down 279 and 91 points, respectively, at the end of trading on Friday after a significant recovery, but the day-end figures failed to capture the panic that struck investors during the day. 

Crisis faced by NBFCs in India

• Non-banking financial companies (NBFCs) were the major force behind Friday’s extreme volatility. Shares of Dewan Housing Finance Corporation Ltd (DHFL) had lost 42% of their value by the end of trading, after having fallen 60% during the day. 
• Other financials such as Indiabulls Housing Finance, LIC Housing Finance, and Repco Home Finance also witnessed similar steep falls.
• The market panic was attributed to DSP Mutual Fund’s sale of bonds worth ₹300 crore issued by DHFL at yields higher than normal.
• Its leading to fears that it could be a precursor to higher borrowing costs that adversely affect the profitability of NBFCs.
• The Infrastructure Leasing & Financial Services Ltd.’s continuing default on its various liabilities also shook investors. 
• The 29% fall in shares of Yes Bank, after the RBI refused to extend the term of its chief executive officer beyond January, further added to the panic. 
• But Friday’s fall was not simply limited to financials, as scrips across the board witnessed panic-selling.

Why it’s called alarming?

• The market’s impressive recovery from the day’s lows, which was fuelled by strong institutional buying.
• It has offered some reason for optimism to investors, who believe the fall was simply a temporary correction in a bull market. 
• Such optimism may be warranted, at least partially, after looking at how both the Sensex and the Nifty have recovered since their previous deep sell-off in February.

Way foward

• The market breadth continues to remain a major concern since the last sell-off. 
• Midcap and smallcap indices have failed to replicate the recovery that has been witnessed in the Sensex and the Nifty since February.
• The panic sell-off also raises the alarm about stretched valuations and other risks faced by the Indian markets.
• The depreciating rupee and the likely increase in the fiscal deficit in the run-up to the general election are the most immediate concerns.
• The need for corporate earnings to catch up with current valuations is another. The systemic risks posed by rising interest rates to corporate debt and various lenders also cannot be ignored.
• Investors, as well as financial market regulators, will do well to understand and act against these risks.

UPSC Prelims Questions: 

Q.1)  With respect to the Reserve Bank of India (RBI), consider the following statements:
1. RBI regulates all the Non Banking Financial Companies (NBFC) in India.
2. National Bank for Agricultural and Rural Development is jointly held by RBI and the Government of India.
Which of the statements given above is/are not correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer:  C

UPSC Mains Questions:
Q.1)  The recently panic sell-off raises the alarm about risks that face the Indian markets. Why is it so? Critically examine. 

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