Indian Markets Face Turbulence Amid Tariff Changes

The Indian stock market has faced challenges recently. For six consecutive days, the BSE Sensex has closed lower. This decline reflects a major sell-off by foreign institutional investors (FIIs) and portfolio investors (FPIs). Mixed earnings reports and concerns over the tightening of tariff regimes in the United States have also contributed to this downturn. The BSE Sensex dropped by 122.52 points, closing at 76,171.08 points, while the Nifty50 fell by 26.44 points to close at 23,045.25.

Impact of U.S. Tariff Policies

U.S. President Donald Trump’s recent directives to restore tariffs on steel and increase aluminium tariffs to 25% have raised concerns in Indian markets. These measures aim to protect American industries from unfair trade practices. However, Indian manufacturers fear a potential influx of cheaper Asian exports. This could lead to price reductions and increased competition in the local market. JSW Steel reported a decline in its Net Smelting Return (NSR) in India, further denoting the impact of these tariffs.

Foreign Institutional Investors’ Behaviour

FIIs and FPIs are increasingly shifting their investments towards U.S. treasury bonds. This trend arises from a search for safer investment options amid modest returns from Indian markets. Factors such as slow domestic earnings growth, high valuations in mid and small-cap stocks, and persistent inflation have contributed to this shift. The relationship between bond yields and stock markets is inverse; as U.S. bond yields rise, foreign investors tend to move away from Indian equities.

Domestic Market Sentiments

The ongoing selling by FIIs has impacted market sentiments. Since the start of the year, FIIs have sold approximately ₹93,907 crore in the cash market. Although domestic institutional investors have attempted to compensate for these outflows, the overall market sentiment remains fragile. The lack of impressive dollar-denominated returns from Indian equities has further discouraged foreign investment.

Mid and Small-Cap Stocks Correction

Mid and small-cap stocks are experiencing a sharp correction due to the ongoing sell-off. Last year, many investors had directed funds into these segments. The current market conditions have led to a strategic shift towards large-cap stocks. Analysts suggest that previous valuations in mid and small caps had reached unsustainable levels, prompting this correction.

Future Market Outlook

The outlook for the Indian market remains uncertain. Potential trade wars under Trump, geopolitical tensions, and slowing global growth could influence market trends. Experts believe that FIIs may eventually return to India, but the timing remains unclear. Signs of economic growth and a potential decline in the dollar could incentivise foreign investments. Meanwhile, systematic investment plan (SIP) flows are expected to remain strong, potentially absorbing the selling pressure in the market.

Questions for UPSC:

1. Discuss the impact of U.S. tariff policies on global trade dynamics.
2. Critically examine the factors influencing foreign institutional investor behaviour in emerging markets.
3. Explain the significance of mid and small-cap stocks in the Indian equity market.
4. With suitable examples, discuss the relationship between bond yields and stock market performance.

Answer Hints:

1. Discuss the impact of U.S. tariff policies on global trade dynamics.

1. U.S. tariffs can disrupt supply chains and increase costs for global manufacturers.
2. They may lead to retaliatory measures from other countries, escalating trade tensions.
3. Tariff increases can result in inflationary pressures in importing countries.
4. Emerging markets may face challenges due to potential dumping of cheaper goods.
5. Long-term, tariffs can shift trade patterns and encourage protectionism globally.

2. Critically examine the factors influencing foreign institutional investor behaviour in emerging markets.

1. Economic stability and growth prospects attract or deter FIIs.
2. Political risk and regulatory environment affect investor confidence and decisions.
3. Returns on investments compared to developed markets influence fund flows.
4. Currency strength and exchange rate volatility impact foreign investment attractiveness.
5. Global economic trends, such as interest rates in developed markets, also play important role.

3. Explain the significance of mid and small-cap stocks in the Indian equity market.

1. Mid and small-cap stocks often provide higher growth potential compared to large caps.
2. They contribute to market diversity and can drive innovation in various sectors.
3. These stocks are generally more volatile, offering both higher risk and reward opportunities.
4. They play important role in the economic development of emerging sectors in India.
5. Investors often seek mid and small caps for diversification and to capitalize on market trends.

4. With suitable examples, discuss the relationship between bond yields and stock market performance.

1. Bond yields and stock prices have an inverse relationship; rising yields often lead to falling stock prices.
2. For example, when U.S. Treasury yields increase, investors may prefer bonds over equities.
3. Higher bond yields can indicate rising interest rates, affecting corporate borrowing costs.
4. In times of economic uncertainty, investors may flock to bonds for safety, reducing stock demand.
5. Conversely, declining bond yields can boost stock market performance by making equities more attractive.