Opinion | Has the IL&FS episode taken wind out of market?

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26 Aug, 2025 12:21

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Shishir Asthana

A bearish mood has gripped the market even though broad equity indices have fallen only 7 percent from their recent highs. While stock prices had started losing value since the start of the month, the momentum picked up over the last one week after IL&FS started defaulting on its obligations. This triggered concerns on the financial strength of non-banking financial companies (NBFCs), the robustness of debt markets, the credibility of credit rating companies and so on.

While markets have pulled back from their lows, the question now is whether the worst is behind us. To answer that, let us look at what triggered the recent bout of selling.

The fall in stock prices gathered steam after it was reported that infrastructure finance company, IL&FS defaulted on certain loan payments. With over Rs 90,000 crore in debt IL&FS is deemed a systemically important NBFC. So the talk of default was enough to rattle the entire financial system. Rating agencies woke up to the reality and downgraded IL&FS after the default.

Mutual fund investors had to realign their portfolio taking into account this change in rating. DSP Merrill sold bonds of housing finance company DHFL to adjust its portfolio and meet redemption obligations. As the DHFL bond was illiquid, the fund sold the bonds at a higher impact cost. This panic in the bond market spread to the equity markets with housing finance companies leading the fall.

The fall was arrested only after LIC Chairman VK Sharma said all options were open, including an increase in its stake to avoid the collapse of IL&FS. At the same time, Indiabulls Housing Finance, one of the stocks that was hammered, managed to raise Rs 2,200 crore at 8.36 percent since September 21 via commercial papers. This included Rs 500 crore on a day when its stock was down by over 8 percent.

While this turn of events suggested an end in sight for the IL&FS issue, the selloff has highlighted the structural weakness in the market. Liquidity has been tight for nearly a year and the current chain of events have made the scenario bleaker. Finance Minister Arun Jaitley has asked the central bank to ensure there is enough liquidity in the system. RBI has said it will be using the open market operation (OMO) route to pump in liquidity. The first tranche is for Rs 10,000 crore.

But these measures have failed to cool the bond markets where yields continue to remain high. For equity market too the mood continues to be bearish. This reflects in the performance of India VIX volatility index. The hit to investor confidence has led the VIX index to a high of 17.58 in recent times. Other yardsticks also show weakness. For every stock that is touching a new 52-week high, there are 30 stocks that are touching 52-week lows. Out of the 22 indices in the BSE, 14 are within 5 percent of their 52 week low.

In terms of fundamentals too, the market has nothing much to offer. Though listed firms reported better-than-expected numbers in the quarter ended June, earning yields continue to fall, suggesting markets have moved ahead of fundamentals.

Moreover, the structural weakness in the market is aggravated by headwinds such as the ongoing trade war between the US and China, turmoil in currency markets and withdrawal of funds from emerging markets because of tightening global liquidity as the US Federal Reserve hiked rates. Further, with important state elections around the corner which will be followed by general elections uncertainties are building up in the market. In short, the choppiness is likely to continue.