Some events have the power to reshape human lives, particularly consumption and investment patterns. Many experts believe the current coronavirus-led crisis could be that event. The uncertainty fueled by the COVID-19 pandemic has roiled stock markets across the world. Widespread restrictions have been placed on the movement and gathering of people. Many market participants and investors are asking for a temporary shutdown of the financial markets to curtail irrational selling. But shutting down the stock markets is not as simple as it sounds. Before knowing why stock markets cannot be shut despite a meltdown, let us discuss the rationale behind the demand.
The rationale behind the call
The government announced a nationwide lockdown of 21 days on March 24 to slow the spread of COVID-19. It essentially brought the economy to a standstill with almost all factories and establishments shuttered down except those involved in the manufacturing and supply of essential items. All people have been asked to stay at home and practice social distancing. Stock markets had been falling since the start of March. But the fall deepened after the state government’s started placing limited restrictions on economic activities. Benchmark indices like Nifty and Sensex fell 23% each in the month of March.
Foreign investors and domestic investors equally pulled out money from equities as investors sought security in cash holdings. The massive sell-off in March led to an erosion of over Rs 33 lakh crore in the market capitalisation of all BSE-listed firms. Such was the selling pressure that trading had to be temporarily halted on multiple occasions as markets breached the lower circuit. India is not an outlier. With fears of a severe recession looming over the global economy, stock markets across the world witnessed a meltdown.
Considering the severity of the selloff, many investors and market participants called for the closure of the stock markets. The government and the Securities and Exchange Board of India have not considered the demand. The market regulator placed curbs on short-selling in the equity derivatives segment to curtail volatility but has largely refused to consider the closure of the market. Why did the regulator not heed the call? Here is why stock markets cannot be closed despite a fall.
Why the markets cannot be closed
The sell-off is driven by irrational fears and uncertainty. Stock prices fall and rise. But the current decline is different because there is still no clarity on the time needed for the situation to normalise. Investors are good at assessing risk which is relatively simple in events such as financial crisis, but uncertainty cannot be factored in. In a nutshell, the market is already in a turmoil without a clear timeline and closing the markets completely will lead to additional panic. The closure will curb investors’ access to their assets which can lead to severe panic and instability. The closure may halt the sell-off for the time being but may lead to a larger sell-off after trading resumes. Closure of the stock market is similar to curbs on withdrawal from your bank account. Blocking access to his/her assets will not be taken lightly by any investor.
Another reason why the stock market cannot be shut despite meltdown is liquidity. Closing the stock markets will affect liquidity and lead to systematic risks. The government will have to guarantee the value of the frozen assets to avoid margin calls. The resumption of the markets will lead to the problem of which financial asset to unwind first. Since all the financial products are interconnected, the government will have to chart out a complex mechanism for the resumption. It could lead to substantial erosion in the value of the assets. Foreign investors are major participants in the Indian markets and inadequate liquidity will have a negative impact on foreign investments.
Closure of the stock markets will also send a negative signal to the global investment community. It will be a sign of inherent weakness in the country’s financial system. No major economy has shut the stock markets and instances of complete closure are rare. Stock markets in the US were closed in the wake of terrorist attacks in 2001. But the BSE and National Stock Exchange were neither closed during the financial crisis nor during the terrorist attacks in Mumbai.
There are several reasons why the stock markets cannot be closed despite a loss. The government and the regulator should monitor the situation and take limited measures as and when required. A fully functioning stock market with sufficient safeguards is the best option in turbulent times.