The Indian stock market is currently facing a severe correction, with major indices such as the NIFTY50 and SENSEX experiencing persistent declines. On Monday, both indices were down by almost 1%, signaling a continued downward trend. By 10:30 AM, the NIFTY50 had dropped over 200 points, trading at 23,210, while the SENSEX had fallen 700 points, hovering around 76,725. This downward movement follows a 2.4% fall in the benchmark indices last week, as several global and domestic factors weigh heavily on Indian markets.
In this article, we delve into the key reasons behind the ongoing fall in the Indian stock market.
Unabated FII Selling
One of the primary drivers of the market’s decline is the continued selling by Foreign Institutional Investors (FIIs). Once prominent players in the Indian equity market, FIIs have significantly reduced their holdings in Indian stocks, leading to a capital outflow. In 2024, net buying by FIIs in the Indian market plummeted by 99%, falling from ₹1,20,000 crore in 2023 to just ₹427 crore. Provisional data for the first ten days of 2025 shows that FIIs have sold over ₹18,000 crore worth of equities in the secondary market.
This dramatic reduction in FII investments is largely attributed to changing global market conditions. As US Treasury yields rise and the economic outlook for emerging markets, including India, weakens, FIIs are shifting their focus towards safer investments like US Treasury bonds, which offer better returns with lower risk.
Rising US Treasury Yields
The sharp rise in US Treasury yields has further compounded the situation for Indian markets. In particular, the yield on 10-year US Treasury bonds surged from 3.6% in September 2024 to 4.7% in January 2025, reflecting a substantial increase of 32% in just four months. This uptick in yields indicates two major trends:
- Inflation Concerns: The rise in Treasury yields suggests that inflation may be on the horizon in the US, which could delay interest rate cuts or lead to a tightening of monetary policy in the future.
- Capital Flow to Safe Assets: As Treasury yields rise, investors are increasingly moving capital into safer assets like US government bonds, offering higher returns with lower risks. This shift has led to further capital outflows from Indian markets, pressuring domestic equities.
The increased appeal of US Treasuries, due to rising yields, has exacerbated the outflow of foreign capital from Indian equities, creating additional downward pressure on the stock market.
Rising Dollar Index
The rising Dollar Index is another significant factor putting pressure on Indian markets. When foreign capital moves out of emerging markets like India, it often leads to depreciation of the local currency. In 2024, the Indian Rupee weakened by nearly 4% from its peak in September, primarily due to the strengthening of the US Dollar.
This devaluation of the rupee has several implications for the Indian economy. Firstly, it raises the cost of imports, especially crucial goods like oil, thereby increasing the import bill. Secondly, the depreciation of the rupee fuels inflationary pressures within the domestic economy.
Moreover, the fall in the rupee reduces the returns for foreign investors in rupee-denominated assets, making Indian equities less attractive. This has led to a continued exodus of foreign capital from Indian markets, further contributing to the ongoing market decline.
Slower GDP Growth
India’s GDP growth forecast for FY25 has been revised down to 6.6%, marking the lowest growth rate in four years. This downgrade reflects challenges within the economy, including slower credit growth, reduced consumer spending, and a decline in demand. The Reserve Bank of India (RBI) had previously projected a 7.2% growth rate, making the new forecast a significant downward revision.
Several factors contribute to the slowdown in GDP growth:
- Reduced Investment: Both public and private investments have slowed down, which has hindered economic expansion.
- Weak Manufacturing: A slowdown in the manufacturing sector has had a ripple effect on overall growth, limiting the potential for recovery.
- Lower Consumer Spending: Consumer demand has weakened, partly due to persistent inflation and high interest rates.
The prolonged period of high interest rates has also led to a reduction in credit growth, which fell to 11% in 2024, down from 16% in 2023. This slower pace of credit growth has had a negative impact on economic activity, dampening overall demand and investor sentiment.
Lofty Valuations Amidst Lack of Growth
Despite India being one of the fastest-growing economies globally, valuations in the Indian stock market—particularly in the NIFTY midcap and small-cap indices—remain elevated, even though underlying earnings growth for many companies has been relatively weak. This disconnection between stock valuations and earnings growth has led to a decline in investor appetite for Indian equities at current price levels.
The market is also grappling with the upcoming Q3FY25 earnings season, which is expected to show weak results. As per early business updates, many companies are struggling with the current economic conditions, suggesting that the earnings growth may be lower than expected.
Investors are hesitant to pay premium valuations for stocks in the absence of strong growth, which has contributed to a further correction in the market.
Conclusion
Despite India being the world’s fastest-growing major economy with a 5.4% GDP growth in Q2FY25, the stock market continues to face significant challenges. Foreign Institutional Investors have been pulling out capital from the secondary market, further exacerbating the ongoing decline. While FIIs are still investing in primary market opportunities through Qualified Institutional Placements (QIPs) and Qualified Institutional Bids (QIBs), their involvement in the secondary markets remains limited.
Global market cues also remain weak, with both the US and China facing economic struggles. The rising possibility of a trade war between the US and China is adding to the uncertainty, which is negatively affecting market sentiment.
That being said, there is some optimism among investors as they look forward to the upcoming Union Budget. There is hope that the government will announce fiscal stimulus measures or economic reforms that could support growth and restore investor confidence. A well-crafted budget could potentially end the dry spell in the Indian markets and provide much-needed support for the economy.
In the short term, the market correction may continue, but long-term investors should keep an eye on the opportunities that may arise once the market stabilizes. If the economy shows signs of recovery, Indian markets could present substantial growth potential. Therefore, investors should remain cautious and strategic, taking into account both risks and potential rewards.
