The S&P BSE Sensex fell 1.64% on Thursday as news came in of India conducting surgical strikes across the Line of Control in Kashmir on terrorist camps.
Almost all other Asian indices were up, unfazed by the panic in the Indian market.
The European markets, too, rallied, apparently shrugging aside the prospect of open hostilities breaking out among two nuclear-armed states in the subcontinent.
Surprisingly, even the Karachi KSE 100, after initial jitters, ended the day down a mere 0.15%.
And in India, foreign portfolio investors bought a net Rs3,413 crore worth of stocks in the cash market and also Rs876 crore of index futures on Thursday, according to data from the National Stock Exchange (NSE), suggesting a complete absence of panic.
That raises the possibility that the Indian market, which had in any case become frothy, took the opportunity to book profits.
After all, what better excuse could there be?
Several analysts said the Indian equity market was ripe for a correction, given stretched valuations in spite of little change in earnings growth.
Inflows of funds from foreign institutional investors kept fuelling the market, leading to a lot of froth.
On the valuations front, too, the Indian equity market is expensive compared to other emerging market peers. So market participants may have seized the opportunity to lighten positions, some experts point out.
Also, if one looks at the derivatives segment, average open interest rose in August to its highest level since 2010—an indicator that the Indian equity market is highly leveraged and if at all there is an unwinding, it may lead to sharper cuts.
As a result, NSE’s volatility index (India VIX), or the fear gauge, which has been remarkably complacent, spiked 33.23% on Thursday to close at 18.45.
As the chart shows, that’s still well below the highest level of the India VIX seen this year, when it was 25.97 in February, at a time when the markets were plunging thanks to the China devaluation scare. As the chart shows, the fall in the market was much more on several other occasions.
The high valuations also suggest a lack of confidence among market participants. “In the September series, on a provisional basis, rollovers in Nifty stood at 64%, which is lower than its three-month average. Even in Bank Nifty the rollovers were lower. This indicates that people are reducing their positions and follow-up positions are not being built in because there is lack of confidence the market will surge to higher levels in the near-term given the uncertainty,” said Chandan Taparia, a technical analyst with brokerage firm Anand Rathi.
For the longer term, experts remain bullish on the India story and expect the equity market to recover as the tension subsides.
“While the initial response of the financial market has been negative, we believe such attacks are unlikely to have any material impact on the markets. For example, the Kargil war was fought between India and Pakistan, between May and July 1999. During the aforesaid period, Sensex and Nifty declined by 286 points and 79 points in three initial trading days respectively, but recovered thereafter and ended higher by 652 points and 191 points when the conflict ended,” Soumya Kanti Ghosh, chief economic adviser at the country’s largest lender State Bank of India, said in a note.
There are other logical reasons for believing that the situation is unlikely to lead to full-fledged hostilities. That’s because Pakistan’s army is denying that any raid took place at all—they claim it’s an “illusion”. If so, the question of retaliation does not arise. And the Indian side has said that for their part, the strikes are over. That seems to suggest that any action will be limited to cross-border shelling, which the markets will take in their stride.
Of course, with so much tension between the two countries, there’s no telling when any incident could lead to a sudden escalation. That is why most market participants advise investors to exercise caution, because pressure on Indian equities may continue in the near term.