₹11 LAKH CRORE WIPED OUT: HOW THE US–ISRAEL–IRAN CONFLICT SHOOK INDIAN MARKETS

By Ayan Kr Gogoi

Investor wealth equivalent to approximately ₹11 trillion has been wiped out from the Indian stock market in just a matter of days as rising tensions between the US, Israel and Iran have created havoc on global financial markets and prompted a sudden flight to safety across all asset classes. Combined with a fast-paced, geopolitical crisis in West Asia, investors on Dalal Street experienced a sudden

influx of panic selling, displaying further evidence of the interconnectedness between conflict on a global scale and the capital markets. The sudden sell-off erased nearly ₹11 lakh crore (₹11 trillion) in market capitalisation, highlighting the scale of investor panic triggered by geopolitical uncertainty. 

 Figure 1: ₹11 trillion investor wealth erosion in Indian stock markets following geopolitical            tensions 

As news emerged about potential retaliation and an increase in military action, the pace of selling picked up greatly because people were concerned about the potential for a larger regional conflict. Investors were concerned about the uncertainty surrounding the situation and they rushed to reduce their investments in stocks (equities). The BSE Sensex dropped by more than 1,100 points, while the Nifty 50 fell by nearly 385 points, reflecting widespread selling pressure across sectors, resulting in a decline across the broader indices and losing significant amounts of market capitalisation. Midcap and small cap stocks, which are often at greater risk in times of volatility, were hit especially hard as traders moved quickly to protect profits that had occurred over the prior few months. Broader indices reflected the same weakness, with mid-cap stocks falling about 2.26% and small-cap stocks declining roughly 2.24% during the sell-off. 

 Figure 2: Decline in benchmark indices during the geopolitical market shock 

A well-known sequence of events underlies the market reaction. A geopolitical conflict occurs in an energy-sensitive area, heightening concerns about the possibility of supply interruptions from crude oil. The prices of oil rise sharply. Concerns about inflation return. Central Banks will have to adopt tighter policy restrictions. The values of equities already under pressure from interest rate expectations will be stressed. Whist the response may seem abrupt, the process is easily recognized by other participants in the marketplace. Market volatility also surged sharply during the period, with the India VIX rising by nearly 25%, signalling heightened uncertainty and expectations of larger market swings. 

  Figure 3: Surge in market volatility (India VIX) 

India greatly depends on imported crude oil; and therefore, if oil prices increase by several dollars per barrel over an extended period, India will have to pay more to import oil, which will drive up the country's import bill and increase both current account deficit (CAD) and rupee depreciation. Higher energy costs subsequently translate into increased retail inflation, which currently presents the Reserve Bank of India (RBI) with the challenge of making decisions that must weigh growth against price stability. Investors, however, tend to be cautious in their investment decision-making process when confronted with anxiety over the likelihood that inflation will remain persistent or will be very difficult to control, as well as when they believe that at least for the immediate future, there will be no change in interest rates. 

Foreign institutional investors (FIIs), who usually adjust their exposure quickly during periods of elevated global risk, were seen selling nearly ₹11,000 crore worth of Indian equities over two trading sessions. This flight-to-safety was evidenced by rising gold prices and increases in the U.S. dollar's value against other currencies. At the same time, the rupee USD/INR, was under pressure; as a result, imported inflation was a concern. 

The sector performance showed justified cautious behaviour. Financials and rate sensitive corrected by much due to concerns about liquidity and credit growth if global volatility continues. Materials and capital goods are proxies for economic momentum; they also deteriorated due to fears that elevated global financial instability would negatively affect global economic demand. In contrast, more cautionary sectors such as consumer and pharmaceuticals displayed relative strength, while some defence-related stocks received some attention based on the view that there could be significant increase in Geopolitical spending levels. 

Even though the losses from this erosion are significant, experienced market participants advise against viewing this event as an example of permanent damage. Historically, in India, equity markets have typically rebounded after large geopolitical shocks if sufficient domestic fundamentals are intact. In terms of the economy, there hasn’t been much change in terms of corporate earnings trends, infrastructure expenditure, or consumption trends in the near term. The only thing that has changed is how people feel about these issues. 

Duration is now the most important variable. If geopolitical risks decrease and crude oil prices stabilise, markets could recover their lost ground at a similar rate to their rate of retreat. Conversely, a prolonged escalation that keeps the price of oil elevated will likely result in continued volatility; further pressure on margins among many sectors; and delays to foreign capital inflows. 

This historic episode serves as a reminder to all investors of the fact that markets price uncertainty before they respond to fundamental values. Historically, when markets experience sharp corrections, it has been due to fear rather than the value being impaired in the long run. Nevertheless, it is still important for investors acting in such an environment to be prudent. Geopolitical headline events will drive all investment behaviour; thus, all investors must have a disciplined, patient approach to allocate their assets, and to monitor closely both oil price and currency price movements. 

India has seen an ₹11 lakh core decline in market value as a direct result of day-to-day and surrounding events that are happening hundreds of miles away. Moving forward, as this ongoing story develops, Dalal Street will closely watch both what happens throughout West Asia and what happens to corporate earnings (i.e., analytics) in India. For the time being, the market is cautious, and the mood is one of volatility (which has replaced the once optimistic attitude).