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Top 3 Reasons Why The Indian Stock Market Crashed

17/02/2016 8:22 AM IST | Updated 15/07/2016 8:26 AM IST
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Indians walk in front of a digital board displaying share price information on the facade of the Bombay Stock Exchange (BSE) building in Mumbai, India, Tuesday, Jan. 6, 2015. Global stocks sank Tuesday for a second day as slumping oil prices and concern Greece might leave the European currency union fueled unease about the global growth outlook. The BSE sensex fell by over 900 points in one of its worst falls Tuesday, according to a news agency. (AP Photo/Rajanish Kakade)

A few days ago the United Nations pinned India as the fasted growing economy of the world. India's economy for the third quarter grew 7.3%, while on an annualized basis the figure was 7.6%. Not that this is a great figure given the expectations of investors but it is way better than Russia, Taiwan and Brazil that are facing recession. Not to mention China's growth falling to the lowest level in 25 years. Now here is the question -- if everything is so peachy, then why did the Nifty index break the 7000-level, which was last seen in the pre-Modi era? Are the reforms going haywire or are the policies not hitting the right chord? Well, it is neither. Here are the three critical reasons that explain the massive sell-off in India.

Non-performing assets (NPAs) and bad loans

If the financials of a company are weak, it is going to fail, no matter the kind of policy you follow. This is what exactly happened with India. Investors have gradually lost interest in India's growth story because of ever-increasing NPAs and bad loans of public sector banks. In monetary terms, NPAs and bad loans of public banks is ₹1.14 lakh crore equivalent to 12% of all the bank loans in India. This amount is more than enough to cripple any financial system in the world.

Investors have gradually lost interest in India's growth story because of ever-increasing NPAs and bad loans of public sector banks.

In 2015, RBI chief Raghuram Rajan offered an opportunity to banks to clean up their mess by offering five interest rate cuts. But the problem came when in a bid to increase profitability the banks did not pass the benefits to the end-customers. This limited the credit growth and hence, the whole plan backfired. Apart from the RBI chief, the Finance Minister also offered a funding of ₹20,000 crore in 13 troubled public sector banks, under the Indradhanush initiative. This plan, too, backfired.

Offering more funding gave banks an opportunity to play with liquidity which ultimately resulted in the creation of more provisions. This leniency negatively impacted the banks' financials. Believe it or not, the NPA ratios are as same as the numbers recorded just before the recession in 2008 started. In a matter of just one year, the market value of almost all public sector banks, including the State Bank of India, have more than halved due to the NPA woes and poor profitability.

A 40% jump in banks' provision coupled with weak assets to the tune of 85% of the whole banking sector and failure of passing the stress ratio test prompted the banks to post weak financials which ultimately weighed on the Nifty Index.

Federal Reserve statements

Ever since ex-Federal chief Ben Bernanke stepped down and Janet Yellen took his place, she has been talking about raising interest rates. However, she never actually did so until December 2015. The very mention of "raising interest rates" by Yellen created panic amidst wild speculation in emerging economies like India. The impact of the statement is such that it strengthens the US dollar which in turn results in capital outflows from emerging economies leading the investors to turn towards the safe haven, gold.

The very mention of "raising interest rates" by Yellen created panic amidst wild speculation in emerging economies like India.

Just a month after raising interest rates, Japan introduced an era of negative interest rates. This February, referring to the negative interest rates, she refuted any chances of slashing down the interest rates in the negative zone. This triggered the dollar to strengthen by 1% in most cases, hence, resulting in a massive sell-off worldwide. While her statements are not uncalled for, I believe one has to take into account the holistic scenario including speculators, investor sentiment and riskiness of equities.

The crude oil crash

Technically, India is benefitting from the crude oil crash but it is still one of the prominent reasons why the stock markets crashed. This isn't just a commodity, but something that runs a country's manufacturing and industrial plants. A crash in crude oil indicates a supply glut. Lower demand takes place when an emerging economy is not producing enough. This ultimately leads to a slower growth.

Crude oil has crashed over 80% in a matter of 18 months to about $27 a barrel. Experts are predicting the crude oil to fall further fall to $20 a barrel. This will definitely have a lasting impact on both developed and developing economies, and has already stalled growth of countries like China, Russia and Brazil.

The crude oil crash has indirectly had a negative impact on steel producing countries like India, pushing steel-making companies towards losses.

The crude oil crash has also pushed prices of commodities like iron and steel to multi-year lows. This has indirectly had a negative impact on steel producing countries like India, pushing steel-making companies towards losses. A loss-making company cannot repay dues from banks, which results in a bad debt or an NPA. For example, in the third quarter the Steel Authority of India Ltd posted losses to the extent of ₹ 1,529 crore while Tata Steel's losses mounted to ₹ 2,127 crore.

This is vicious circle which can only be broken if crude oil stabilizes at a particular level so that countries can strategize a way out of the crisis.

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