Indian Stock Markets - Who is the Fool?

Stock exchanges are one among the various financial intermediaries. A stock exchange may be defined as a place or market where securities (ownership or debt) of joint stock companies and of government or semi-government bodies are dealt in. It is an essential concomitant of the capitalist system of economy. It is indispensable for the proper functioning of corporate enterprise. It brings together large amounts of capital necessary for the economic progress of a country. It provides necessary mobility to capital and directs the flow of capital into profitable and successful enterprises. It acts as the barometer of general economic progress in a country and exerts a powerful and significant influence as a depressant or stimulant of business activity. It is often the platform where one can obtain an accurate or near-accurate valuation of corporate enterprises.

For many years since independence, the Indian financial system was caught in the vice of narrow, inflexible regulations that made it tough to maneuver. Real change started when the then RBI Governor RN Malhotra kicked off a gradual deregulation in 1988. Matters came to a head on September 23, 1991 when India’s foreign exchange reserves touched rock-bottom levels of US$ 0.93 billion – barely enough to cover even 14 days’ oil imports. The nation suffered the ignominy of pledging 65 tons of gold with the Bank of England to raise US$ 445 million which helped it tide over the worst-ever forex crisis in its history. Eventually, the agreement signed with the IMF ushered in a wave of reforms and the winds of liberalization, privatization and globalization blew through the length and breadth of Indian economy and its financial system. Indeed, the financial system in India at present is a far cry from the regulated system in vogue in the 1960s and 1970s.

It needs to be highlighted that stock markets were in operation in India for a long time prior to the reforms. Stock trading began in India on July 9, 1875 when native brokers formed The Native Share and Stock-Brokers’ Association in the then Bombay. In fact, it was the first such exchange in the whole of Asia. However, it was only in the post-reforms era that stock markets began to get their rightful share of limelight. Today, the Indian stock market ranks among the best in the world in all respects – be it market capitalization, number of companies listed, regulatory framework or transparency. Again, India has the only-one-of-its-kind T+2 settlement system and steps are underway to move to real-time settlements. The Bombay Stock Exchange Ltd (BSE) and the National Stock Exchange of India Ltd (NSE) are the two primary stock exchanges in India. In addition, there are 22 Regional Stock Exchanges. However, the BSE and the NSE have established themselves as the two leading exchanges and account for about 80 per cent of the equity volume traded in India. Due to the existence of the Futures and Options (F&O) segment in the NSE, it tops in terms of the volume of transactions, though it is the BSE which has the largest number of listed companies. The two key stock indices are the BSE Sensex - for Sensitive Index, as coined by Deepak Mohoni - comprising 30 top stocks and the NSE's S&P CNX Nifty - for NSE Fifty - comprising 50 top stocks.

With the opening up of the economy and aided by stellar performance of the economy, the stock markets have wrested their rightful share of limelight, so to speak. The stock markets have set a scorching pace of growth. Also, there were the series of reforms unleashed, starting with giving teeth to SEBI, allowing foreign institutional investors to invest in India, introduction of rolling settlement, banning the badla system, moving to screen-based trading, introduction of new instruments, internet trading, and finally, demutualization of the exchanges. That today Indian stock markets are on solid grounds is borne out by the fact that within just two weeks of RBI allowing FDI & FII in stock exchanges, NYSE have acquired a stake - of 5 per cent, the maximum allowed for any single investor - in NSE. LSE and NASDAQ are in talks to acquire a similar stake in BSE. Even on the basis of stocks traded, there has been tremendous improvement. From around 1000 points or whereabouts in July 1991, the BSE Sensex is now at levels of 14000+. Then again, the market cap (of BSE stocks) is now more than Rs 35 Lakh Crore; but the P/E ratio has actually come down from 40 in 1991 to between 19 and 23 today.

That brings us to the issue of stock prices. What drives stock prices? Fortunately or not, and like everything else in this world, there is no crystal ball that can show the future price of any stock. Theories on stock price movements are galore and studies on the same can be grouped under three broad headings, viz. fundamental, technical and efficient market hypothesis. All the three together are able to explain away most of the price movements, but uncertainties still remain. It is now accepted that stock prices are a reflection of expectations of investors and changes in the same lead to changes in the prices. And, these expectations are based not just on a particular company's or even domestic economic fortunes, but also on global events. In a way, it can be said that the uncertainty surrounding stock prices is the charm of the game! However, too much of uncertainties is harmful and leads to violent fluctuations in prices. Here, Indian markets score badly - it is leader with respect to volatilities! And, that is the inadequacy of Indian markets...What is the cause for this volatility?

Unarguably, the Indian stock market saga is built on institutional funds. It is a show run by financial institutions. Foreign Institutional Investments in the Indian capital market, which commenced in January 1993, have shown significant increase over the subsequent years. Cumulative net FII investments increased from US$ 827 million at end-December 1993 to US$ 45.3 billion at end-March 2006 and further to US$ 46.9 billion as at end-September 2006 (Source: RBI). On a year-on-year basis, in the year-ended December 2006, FIIs pumped in US$ 8 billion on top of the US$ 10 billion brought in, in 2005. Domestic institutions are also not far behind. Domestic mutual funds, led by UTI and banks have been aggressive buyers all along. However, they have not been of great help when foreign funds are withdrawn, as has been demonstrated quite a few times in the past. A word also needs to be said about the role of Participatory Notes - freely transferable instruments issued by FIIs to its clients who are otherwise not eligible to enter Indian markets (like Hedge Funds) or who wish to remain anonymous. Many a time, RBI and SEBI have expressed their concerns over them and Tarapore-II Committee even recommended its phase-out. The fears expressed by these agencies about PNs - that it helps money-laundering and round-tripping of capital - cannot be dismissed lightly.

The sort of big ticket buying and selling by institutions keep retail investors away from the stock markets. Not that there is anything wrong in institutional investments, but the sheer enormity of the funds at their disposal makes retail investors jittery and gives them sleepless nights! Though the late Dhirubhai Ambani (now immortalized on the celluloid by Mani Ratnam's Guru, aided in no small measure by the riveting performance of Junior B, Abhishek Bachchan) is often credited - rightly or mistakenly - with encouraging the growth of equity cult in India in a big way, the fact remains that the retail investor base has not grown to attain that 'critical mass', the over 9.9 million demat accounts (as at end-Dec 06) notwithstanding. After all, according to the 61st round of NSS, 64.75 per cent of Indians are still illiterate and 52 per cent are unemployed. Low retail participation may partly be attributed to lack of awareness about the stock markets as an investment alternative. The tendency on the part of even educated Indians to derisively dismiss stock markets as 'gambling centres' is strange indeed! It points to the terrible gap in investor education and financial counseling in India. Then again, the cause of equity is not helped in any way by the tendency of some retail investors to enter and exit the stock markets at the wrong times and burn their fingers. Also, there are some too-ignorant-to-be-fit-as-MPs who raise a hue and cry whenever there is a stock market crash. The real fools are the ones who think they can make some quick bucks from the stock market! Add to that the scams - remember Harshad Mehta and Ketan Parekh - and it can be seen that low retail investor participation is both a cause and an effect of volatility in Indian stock markets.

What can be done to boost retail participation? One solution that seems likely to materialize soon is the spread and reach of internet trading. Since its introduction in February 2000, internet trading has grown by leaps and bounds. Data till November 2006 show that trading over the Net formed about 14 per cent of the total turnover. It's still small change when compared to South Korea's 75 per cent, but shows its potential.

Another solution lies in revitalizing the moribund debt market. It will address the concerns over regular returns. It can also, at least partially, meet the requirements of infrastructure funding. SEBI can simplify the trading rules further and at the same time needs to guard against the actions of vested interests. It also needs to take a final view on the fate of regional stock exchanges, which as of now do not seem to have any way forward.

If all these are done, there will be no stopping the Indian stock market zoom! Vrooooom!!!!

Plagiarism? No! Inspired? Yes!

Well, it seems I need to emphasize that I scribble over here primarily to help me hone my writing skills - to take what I consider as two of my dream-exams, to enter the organization / set-up of my dreams. To that end, what I put here as 'Current Affairs Commentary' are not all of my own scholarly insights, but to a large extent, a reiteration of all that I collate from a diverse range of sources. If you may, it can be called 'inspired'; but it'll be painful if the word 'plagiarism' is used.....

Orgnaised retail - Challenges for the players

Well, I have already given my take on the prospects of organised retail in India. Taking it a bit further, today let me look into the challenges for all the players involved.

 

For any serious player in the organized retail space - regardless of it being an Indian or foreign one - space is a serious issue. Yes, the kind of space that is required for setting up a mall is a premium in India, especially now as the realty sector is witnessing an unprecedented boom, amidst fears of a 'bubble in the housing sector'. Land prices are shooting through the roof, not only in Tier I cities, but also in Tier II and, to some extent, Tier III cities. Increased prices mean that the players will have to invest a lot more in land (if they want to own the space) or fork out more as lease rentals.

 

Then there are the much-talked-about supply chain deficiencies in the Indian agri-sector. Procuring all the necessary agri-products, grading them, and transporting them to the various cities can all be logistical nightmares for the players. Rural connectivity in India is, at best, literally a bumpy ride and at worst, non-existent. The players will have to invest heavily in all these support structures.

 

All these inadequacies can be reasonably assumed to find a reflection in the costs of operations of all players. Thus, higher costs to the end-consumer seems inevitable at least in the short-run, unless the retailer - with deep pockets - decides to bear it all (Highly unlikely, let me add!).

 

Next comes the biggest challenge of all - winning over the Indian consumer. Wal-Mart or Reliance or anybody else, will find this the most daunting task. Understanding the consumer psychographics and acting on them is a must to succeed. Indians are a discerning lot and cannot be taken for a ride. The footfalls have to be translated into sales. To assume that it is a cake-walk will be like lulling oneself into complacency. It is not to be forgotten that Wal-Mart had bit the dust in countries like Germany and Korea. Biggies like Reliance need to take caution, because this is a new business for them. Players like Shoppers' Stop and the Futures Group too need to tread carefully as they expand into new locations.

 

As outlined in an earlier post, local mom-and-pop shops are already feeling threatened by organized retailing. News reports suggest that some kirana-wallahs are up in arms against a Reliance store in Ahmedabad. There are also reports that prices of some grocery items are rising as the biggies are doing bulk purchases (As an aside, if that is indeed the case, it calls the bluff of all those who said India is self-sufficient as regards food; is the supply so short as to get exhausted on bulk purchases by someone?).

 

In my view, organized retail will have the immediate effect on a consumer state like Keralam. Here, very little production takes place and people will be ever-ready to switch over to a lower-cost alternative. What can the kirana-wallah do? A lot, if you ask me.

 

As with everything else, there is already a trade union for small traders in Keralam, viz. Kerala Vyapari Vyavasayi Ekopana Samiti. It is a cash-rich organisation. It can bring together all its members' shops and give them a new brand identity. With the cash available, it can contribute to sprucing up all the shops and endow them all with some distinctive features. It should try to replicate the operations of organized retailers in procuring materials and thus exploit the scale efficiencies. Quality has to be ensured and a new brand shop can be created. With the right ideas and will, sky is the limit and they can pose a veritable challenge to organized retailers. The office-bearers of the Samiti should realise that unionism is to be used for activities like these and not for downing shutters on every hartal day and on silly grounds!

 

If this succeeds, it can be replicated in other states too, right?