It is said that the stock market is the mirror of a country's economic growth and prosperity. Also, the economy of a country largely depends on the conditions prevailing in the stock market. A positive sentiment in a stock market helps big as well as small players in the industry set optimistic performance targets which results in increased revenue and profit. The world knows how a crash can affect the economy which it already experienced in the Great Depression of 1929 and the crash of 2008. In both these situations, the economic conditions went from bad to worse affecting people across the world. Given in the next section are the possible results of a stock market crash.
A significant reduction in investments from common as well as high net worth individuals is the direct result of such an event. The prices of stock trade at all time lows after a crash hence, most investors are afraid of making direct investments. So, they prefer to sit on cash till the situation becomes normal. Lack of inflow from investors directly affects the economic growth of the country.
Reduced Corporate Earnings
Less consumption from people directly affects the sales and profits of corporate firms. Companies belonging to almost all sectors are affected by stock market crashes and most of them report huge losses and increased liabilities during this period. Lower incomes of companies ultimately leads to less corporate tax collection by the government which can prove to be a hindrance in implementing pubic welfare schemes. In such situations, companies are in desperate need of finance to fund their operations. However, raising money from primary and secondary markets is extremely difficult after a market crash. When most companies are not living up to the expectations, the overall Gross Domestic Product (GDP) of the economy also decreases significantly.
The impact on the economy is highest due to the job losses caused after a stock market crash. In the period of recession, companies tend to cut costs by laying off employees. With no guarantee of a fixed income, people will not be able to spend money on luxury items. Thus, job losses ultimately affect the consumer durable and real estate sectors greatly. Prices of residential as well as commercial real estate can fall sharply because of a lack of demand which is a loss for people who have already invested in real estate.
Problems for Banks and Financial Institutions
Banks and financial institutions are among the worst affected sector in a financial crisis. Because of job losses, chances of defaulting on loans are very high which in-turn affects the earnings of banks. The asset quality of banks reduces drastically and the percentage of non-performing assets increases. Many banks go bankrupt in such conditions. They find it hard to get potential customers to increase their business and this is a deterrent for economic growth. Since the banking sector is the backbone of the economy, its non-performance affects the economy for a long time.
Low Foreign Investments
When the macroeconomic scenario is difficult, it is very hard to get foreign investments. It has been observed that foreign institutional investors sell their stakes in huge quantities when there is a market crash. For an economy to strengthen, foreign flows are a must, in the absence of which, GDP targets cannot be met.
Low Confidence in Investors
This is mostly because of the losses suffered by people in a stock market crash. Because of low confidence, investors tend to miss out on investment opportunities in stocks and real estate. Even if the situation improves gradually, the economic growth will not get back to the old levels immediately as restoring the lost confidence is a long process.
The stock market can crash due to international as well as domestic factors. Regulators in stock markets and the finance ministry should take prompt steps to avoid a recession - this will help the country achieve continuous economic growth. If the fundamentals of an economy are strong, then sooner or later it is bound to bounce back and regain its high growth percentage. By investing in troubled times at attractive valuations, investors can definitely obtain solid returns in the future.