Indian Stock Market Collapses Nifty 50 Plunges 4.4% Sensex Sheds Over 2% Amid Global Turmoil

Key Points:-

• Nifty 50 dropped by 4.4% in the past week, marking its largest decline since June 2022, while Sensex fell by over 2% in a single session, driven by a combination of geopolitical fears and new regulations.

• Geopolitical tensions, particularly the potential Iran-Israel conflict, have spooked global markets, leading to risk aversion among investors. This situation historically affects energy markets and global inflation, adding to market volatility.

• FIIs pulled out over Rs. 12,000 crores from Indian equities in one week, worsening liquidity and increasing pressure on stock prices, with investors reallocating funds into safer assets like government bonds and gold.

• SEBI introduced new regulations, increasing the contract size for Nifty and Bank Nifty futures from Rs. 5 lakh to Rs. 20 lakh, aiming to reduce speculative trading and bring more stability to the Futures and Options (FO) market.

• SEBI also adjusted lot sizes for index derivatives, reducing the number of trades per contract, which could impact market liquidity. These lot sizes will be reviewed every six months to ensure a balance between liquidity and participation.

• Retail traders may be disproportionately affected, as the new rules require more capital, which could reduce their participation in the FO segment. However, institutional investors may benefit from a more stable market environment.

The Indian stock market has been experiencing significant pressure over the past few weeks, with key indices such as Nifty 50 and Sensex registering substantial declines. Several factors have converged to create this downward trend, including escalating geopolitical tensions, continuous outflows from Foreign Institutional Investors (FIIs), and the latest regulatory changes introduced by the Securities and Exchange Board of India (SEBI). These developments have impacted investor sentiment and raised concerns about the market's near-term trajectory.

Geopolitical Tensions and Their Global Impact

At the forefront of the market turmoil is the growing fear of an impending conflict in the Middle East. The increasing possibility of a war between Iran and Israel has triggered a wave of uncertainty across global markets, leading investors to reassess their risk exposure. Historically, geopolitical crises in the Middle East have caused disruptions in energy markets, inflation spikes, and heightened global market volatility, and this situation is no different.

• The Nifty 50 fell by 4.4% during the week ending October 5, 2024, marking its biggest weekly drop since June 2022.

• The Sensex followed a similar trend, with a decline of over 2% in a single trading session.

These sharp drops reflect a broader risk aversion among investors, who are reallocating their funds away from equities and into safer assets such as government bonds and gold. As long as the uncertainty around this geopolitical conflict lingers, Indian markets are likely to remain vulnerable to further sell-offs, given the interconnectedness of global financial markets.

International Market Reactions

The turmoil in the Indian stock market is part of a larger global trend, with several major international indexes also experiencing significant declines amid heightened geopolitical tensions and market uncertainty. Key performance data includes:

• Nikkei 225: Dropped 3.5% over the past week, reflecting concerns over global economic stability.

• Nasdaq 100: Fell 4.0%, as tech stocks faced selling pressure due to rising interest rates andeconomic fears.

• Russell 2000: Decreased 4.2%, impacted by fears of a slowdown in domestic growth.

• Hang Seng: Experienced a decline of 3.8%, reflecting concerns over China’s economic recovery and its implications for global markets.

• FTSE 100: Shed 2.9%, as British equities reacted to global risk aversion.

These declines highlight the interconnected nature of global financial markets, where investors are increasingly sensitive to geopolitical risks and macroeconomic indicators.

Foreign Institutional Investor (FII) Outflows Continue to Drag the Market

One of the major factors intensifying the market's downturn is the continuous selling by Foreign Institutional Investors (FIIs). FIIs play a crucial role in maintaining liquidity in the Indian stock markets, and their actions have a direct impact on market movements. Over the past few weeks, FIIs have been pulling out significant amounts of capital, a trend driven by the combination of geopolitical risks and a more cautious outlook on emerging markets like India.

• In the past week alone, FIIs sold Rs. 12,000 crores worth of Indian equities, contributing heavily to the downward pressure on stock prices.

• The outflows have been exacerbated by a flight to safety, as international investors opt for more stable markets amid the global uncertainty.

The withdrawal of FIIs not only impacts the broader market but also influences specific sectors, particularly those with heavy FII participation, such as financial services, IT, and energy. The fear among investors is that further outflows could cause a liquidity crunch, putting additional strain on already weak market conditions.

SEBI’s New FO Trading Rules: A Game Changer for Derivatives Market

Amid this market turbulence, SEBI has introduced new regulations that are expected to reshape the dynamics of Futures and Options (FO) trading in India. These changes, part of SEBI’s ongoing efforts to reduce excessive speculation in the derivatives segment, have been met with mixed reactions from market participants.

The key highlight of SEBI's regulatory shift is the increase in the contract size for Nifty and Bank Nifty futures. Previously set at around Rs. 5 lakh, the minimum contract value has now been raised to Rs. 20 lakh. This significant change is aimed at ensuring that only serious investors, particularly institutions, participate in these high-stakes trades, thereby reducing the speculative nature of the FO market.

SEBI’s Goals Behind the New Rules

Curbing Speculation: SEBI’s move to increase the contract size is designed to reduce speculative trading in the derivatives market. By raising the financial bar, SEBI aims to push out smaller, retail traders who may engage in high-risk trades without fully understanding the consequences.

Encouraging Stability: The larger contract sizes are expected to bring more serious, institutional players into the fold, who trade with long-term strategies rather than speculative, short-term bets. This could help stabilize the market and reduce the high volatility seen in indices like Nifty and Bank Nifty, which have historically been prone to sharp swings due to speculative trading activities.

Changes to Lot Sizes

Img credit: zerodha

Apart from increasing the overall contract size, SEBI has also changed the lot sizes for index derivatives. The new rules will have a direct impact on how these futures contracts are structured and traded.

Nifty and Bank Nifty futures contracts, which have traditionally been among the most traded derivatives in the Indian market, will now have fewer lots. This reduction in the number of lots will mean fewer overall trades per contract, which could reduce market liquidity in the short term, particularly for retail participants who rely on these smaller lots for hedging or speculative trades.

Additionally, SEBI’s decision to review and adjust lot sizes every six months will ensure that the market remains responsive to changes in liquidity and participation levels, allowing for future adjustments if necessary.

Impact on Traders and Market Participation

While SEBI’s rules are intended to bring more order and stability to the market, they will also have significant consequences for various types of traders:

Retail Investors: Retail traders who engage in short-term trades are expected to feel the most impact. The increased contract size and fewer lots will make it more difficult for smaller players to enter the market, potentially reducing overall retail participation in the FO segment. However, SEBI’s goal of curbing speculative, high-risk trading means that these retail traders may need to rethink their strategies or face exclusion from the derivatives market.

Institutional Investors: Larger, institutional investors such as mutual funds and proprietary traders are likely to benefit from the new regulations. By curbing excessive speculation, the new rules could lead to a more stable derivatives market, making it easier for institutions to execute long-term trades without worrying about market manipulation or sharp, speculative swings.

Liquidity Concerns and Market Adjustments

While SEBI’s intentions are clear, the new regulations may have some unintended consequences in the short term. Reducing retail participation could lead to a drop in market liquidity, as retail investors contribute significantly to daily trade volumes in the FO market. The reduced liquidity could make it harder for larger investors to enter and exit positions smoothly, potentially leading to higher costs for executing trades.

To mitigate this, SEBI’s periodic review of lot sizes and contract values will be crucial in maintaining a balance between reducing volatility and ensuring enough liquidity in the derivatives market.

Key Data from SEBI’s New FO Rules:

• Contract size increase: From Rs. 5 lakh to Rs. 20 lakh.

• Lot sizes reduced: Fewer lots per contract in Nifty and Bank Nifty futures.

• SEBI reviews every six months: To ensure liquidity and participation adjustments.

Combined Factors Driving Market Volatility

The Indian stock market is currently facing a perfect storm of internal and external pressures. The geopolitical tensions in the Middle East, coupled with SEBI’s new FO trading regulations and FII outflows, are driving the market’s volatility. Investors are grappling with uncertainty on multiple fronts, making it difficult to predict the market’s near-term direction.

• Global risk factors

  : War fears in the Middle East have heightened global volatility, and markets worldwide are reacting to the increased risk premium.

• Domestic regulations

  : SEBI’s new rules are reshaping the way futures and options trading works, influencing participation from retail and institutional traders alike.

• FII outflows

  : Continuous selling by foreign investors is worsening the decline, as capital flight from India contributes to a sharp reduction in liquidity and confidence.

Key Data Highlights:

• Nifty 50 weekly decline: 4.4%—the largest drop since June 2022.

• Sensex single-day drop: Over 2%.

• FII outflows in the past week: Rs. 12,000 crores.

• New Nifty futures contract size: Increased from Rs. 5 lakh to Rs. 20 lakh.

The combination of geopolitical tensions, regulatory changes, and foreign capital outflows is creating a volatile environment in the Indian stock market. Investors, both large and small, are facing uncertainty as global risks continue to loom and domestic market regulations shift. While SEBI's new rules aim to stabilize the market in the long term, the short-term impacts, particularly on retail traders, are yet to be fully realized.

As the geopolitical situation in the Middle East evolves and the market adapts to SEBI’s regulatory framework, investors should remain cautious. The market is likely to continue experiencing volatility in the near term, and a balanced approach to risk management will be critical for navigating these uncertain times.

Bibliography:- https://www.thehindu.com/business/markets/sensex-nifty-fall-over-2-on-war-fears-curbs-on-fo-trading/article68714085.ece, https://www.msn.com/en-in/money/markets/nifty-50-slides-4-4-this-week-posts-largest-weekly-drop-since-june-2022-on-growing-iran-israel-war-fears-fii-outflows/ar-AA1rH8wZ, https://zerodha.com/z-connect/business-updates/sebis-new-rules-for-index-derivatives-heres-whats-changing#:~:text=Currently%2C%20the%20contract%20size%20for,lakhs%20to%20Rs.%2020%20lakhs