The Fall of the Indian Stock Market of Oct 24 - Feb 25: Fundamentals at the Weakest? | Sharad Ranjan, D Narayana

The story so far

Following the peak in September 2024, market indices in India have exhibited a consistent downward trend. The stock prices, particularly those categorized as mid- and small-caps, have fallen considerably. The crash has severely affected the market, with small-cap stocks suffering the most and their volatility has increased. Taking standard deviation as an indicator of volatility, it is seen that the standard deviation of small-cap stock prices at 1231 is nearly twice that observed in mid-cap and Nifty 50 equities.

The interaction of supply and demand is the underlying cause of price volatility across markets, including the equity market. Prices fall as supply rises. High selling pressure from Foreign Institutional Investors (FIIs) has driven the current stock market situation. The offloading of ?2 lakh crore in Indian stocks by FIIs between October 2024 and February 2025 significantly dampened market sentiment. Their equity sales totaled ? 1 lakh crore in 2025. The sharp market drop has panicked many domestic investors, especially those using leverage, who face margin calls and potential losses. This has further spoiled the mood of the markets, casting a pall of uncertainty over investors and traders alike. The key factors contributing to this situation are as follows.

As foreign investors withdrew from Indian markets to pursue opportunities elsewhere, the surge in rupee supply and increased demand for dollars led to the fall of rupee. A 3.54 percent depreciation of the Indian rupee occurred between October 1, 2024 and February 28, 2025, with the exchange rate changing from ?83.9 to ?87.446. When the dollar’s value rises compared to the rupee, it leads to an increased demand for dollars, causing further depreciation of the rupee. A regression model run on data from the period in question, clearly shows that substantial FII withdrawals are depressing market indices. According to the regression analysis, when the rupee fell by ?1 against the dollar, small cap indices plummeted by 840 points, mid-cap stocks declined by 380 points, and large-cap stocks fell by 520 points.

The proximate cause of the stock market crash is the withdrawal of the foreign investors and the fall of the rupee but the ultimate cause has to be found in the slow economic growth, and the resulting weak corporate earnings. Discounting the quarterly GDP growth rates of Q1 and Q2 (for statistical reasons) the last thirteen quarters have reported growth rates well below 7 per cent and six of them well below 6 per cent. These low GDP growth rates have started getting reflected in low corporate earnings which in turn have led to sell-offs. Large-cap companies posted an in-line earnings growth of 5 percent year-on-year, and small-cap companies experienced a broad-based miss as earnings dipped 24 percent YoY. Weak economic growth and poor company earnings could make these markets less attractive to foreign institutional investors (FIIs), who might then invest in economies with better returns. Income inequality has further exacerbated the problem. The National Council of Applied Economic Research’s household income surveys report India’s Gini coefficient, measuring income inequality, rose to 0.410 in 2023 from 0.371 in 1955. As wealth becomes concentrated in fewer hands, a contraction in the demand for goods and services is no surprise.

Some recent events have further exacerbated the weak demand and lower earnings. First, capital expenditure by the Indian government unexpectedly contracted by 12.3 percent in the first eight months of FY25, a significant reversal from the budgeted 17.1 percent growth. This resulted in a decline in gross fixed capital formation, representing investment spending. Second, a parallel trend is the reduction in private sector investment in capital goods as well. The data revealed a sharp 22 percent year-on-year drop in the total value of new project announcements, which stood at Rs 6 trillion ending December 2024 quarter. Compounding this trend was a staggering 52 percent year-on-year plunge in the value of completed projects, falling below ? 1 trillion. The basic reason of slowdown in private capital expenditure leads us back to the situation of slower economic growth.

Third, income tax rates in India have been substantially higher than in many comparable nations, affecting investment and overall prosperity. Corporate tax rates were, in fact, less than personal income tax rates. The last budget, however, offered some relief measures the results of which may be known only much later.

Besides the above, the Indian economy is experiencing apprehension in response to President Trump’s post-re-election statement regarding a review of tariffs imposed on Indian products. Should higher tariffs be enacted, Indian exports would become less competitive to foreign buyers. Because of the increased costs and India’s lack of a monopoly on any exportable goods, the US may buy products from other countries hurting India’s exports. The added tariffs on imports will contribute to the rising costs of goods, further fueling inflation within the economy. Lower tariffs, while benefiting consumers with cheaper goods, threaten domestic industries, leading to factory closures and job losses as businesses struggle to compete with lower-priced imports. Local manufacturers will struggle to match the low prices of imported goods, facing challenges in competing. The market is likely to stay as it is until things become more transparent.

The recent RBI’s out-of-sync rate cut revision has only made things worse. The crucial interest rate cut was long overdue and should have been implemented in line with other major economies. With interest rates in other major economies nearly stable, a rate cut here would make our country less competitive, as fixed-income investments elsewhere offer better returns. With the current market conditions, a more effective approach is to prioritize fiscal solutions—such as GST rate optimization—rather than solely depending on monetary policy or anticipating the return of foreign institutional investors. This policy revision is expected to spur economic growth in India. A strengthening economy, with its promise of higher returns and reduced risk, automatically attracts foreign institutional investors seeking lucrative opportunities.

(Authors: Sharad Ranjan is Professor of Economics at Zakir Husain Delhi College Evening, University of Delhi; D Narayana is Professor of Eminence, School of Social Sciences, Ramaiah University of Applied Sciences, Bangalore)