stock market panics when politics dominates economics

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Stock market panics when politics dominates economics

The Hindu Business Line Thursday, Jun 15, 2006

R. Vaidyanathan

With Dr Manmohan Singh at the helm, economics, it was thought, would dominate politics. But

all signs point to the opposite and are exacerbated by the reservation issue, the speed-breakers

to infrastructure development, and the Naxal threats. This makes the market rather jittery, says

R. VAIDYANATHAN.

The stock market mayhem in May has generated endless discussions, most of which fail tounderstand the nature and role of the stock market. It is important to remember that the marketlooks at the future. There is a continuous flow of information, both positive and negative, and

when the scales are tipped either way, because of information asymmetry or any other reason,

the market slides.

India's markets are highly skewed and shallow and thus the role of foreign institutional investors

assumes importance. Though, in aggregate terms, they constitute a small portion of our market,at the margin the influence of the FIIs is considerable.

The Table lists some of the salient aspects of the market. In 2004-2005, only 40 per cent of thetrade resulted in deliveries at the BSE (26 per cent in the NSE). The picture is no different today.

From this one can infer that a substantial proportion of market participants are day-traders who

square off transactions during the day. They can also be called margin players. Individual

investors only do this as institutions cannot square off within a day in our system and they shouldsettle transactions on a gross basis in the T+2 format.


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Actually, we do not know about the aggregate margins provided by individuals to brokers, and

the financing of these transactions since, currently, the relationship is between the exchanges and

brokers, and the former pull the plug if the latter have not paid the margins or have exceededtheir limits.

Skewed market

A substantial portion of these transactions between individuals and brokers is financed by thenon-banking financial sector, including moneylenders. Millions of individuals have lost heavily

in the recent fall of the market, as they would have borrowed from non-corporate institutions at

exorbitant rates.

In the Indian market, though the listed stocks number over 8,000, only around 250 are actively

traded. Of these, the top ten securities constitute nearly one-third of the traded value, indicatingthe level of skew. In most mature markets, normally no single security has more than one per

cent of the traded value. This skew makes the market illiquid as everybody wants these ten or so

scrips and, when people exit, they also exit from these ten.

Institutional investors, particularly the FIIs, are constantly in search of better returns. The fund

manager is paid based on on his performance and his job is to move funds on a continuous basis.Global funds have to think of geographical allocation and then asset allocation between risky

shares and risk-less government securities, and the portfolio allocation

The fund manager is accountable only through his profits and is not emotional about choosing

between a developing or a developed country, or between European and Asian markets. If

parking funds in Antarctica can fetch gains he will do so with as much vigour as he would inWall Street or Dalal Street.

The India story has been good and, hence, there was much enthusiasm about the market. Whenthe market touched 12,000, there was so much euphoria that ministers and ruling party managers

began to talk about the achievements of the Government. But, unfortunately, markets are more

concerned about the future than the past and start getting jittery when politics dominateseconomic thinking.

Self-goal by government

In April, the Human Resource Development Minister, Mr Arjun Singh, announced reservation ofup to 50 per cent in such institutions as IITs and IIMs. After crying from the rooftops that these

are premier institutes representing Brand India, this was a bolt from the blue, like an FMCGcompany downgrading its premium brand. The callous way the decisions were made and the

debate was closed would have shocked international investors. This apart, the Minister for SocialJustice and Empowerment, Ms Meira Kumar, is talking about reservations in the private sector.

Again, nobody in the Government is very clear on this issue.. Fund managers are not sure if this

a good move. In the absence of clarity, they prefer to believe the captains of industry that thepolicy may be harmful to business rather than creating and promoting equity.


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The second and most important issue pertains to massive investments in infrastructure power,

water, steel, etc. These are getting blocked due to apathy or antagonism of the governments, both

at the Centre and in the States. The NGOs add to the confusion. Classic examples are theBangalore-Mysore Corridor project, which has become a street brawl between the State

Government and the promoters, and the Kalinga project in Orissa, where highways have been

blocked for months now.

Naxal threat

And then there is the Prime Minister mentioning that Naxalism is the biggest threat to India.

More than 60 districts are affected by it, and these are districts where massive infrastructure

investments are expected.

Given the precarious position in Nepal, if it falls to Maoists then many parts of the Naxalcorridor are going to be volatile and almost all the new mega projects expected to come up there

will be affected. There is a three-way tug-of-war being played by the UPA, the NDA and the

Left, and the market does not appreciate such confused polity. It will be argued that the markethad already factored in these variables. But the level of procrastination and the increased

domination over economics by politics has been more visible from the end of April.

As a result the market perceives that the Banking Bill, Pension Bill, etc., are all going to be put

on the back-burner. Even the fuel price increase is too late and too little and the oil companiesmay go to the BIFR if they continue to bleed. The suppressed inflation is a matter of concern as

retail inflation could touch double digits by the festival season. The corresponding increase ininterest rates will also be more pronounced.

The market cannot be talked up or down, as it is popularly believed. If the Government tries to

artificially push up the market by encouraging financial institutions to buy, it will be folly of thehighest order as public institutions such as banks and LIC will be saddled with stocks not worththe paper they are printed on. Neither the enthusiasm of ministers regarding the " robustness of

our economy reflected in the increasing index" nor the complaint that " the fall in index is

manufactured" is justified.

The present dispensation at the Centre is increasingly looking like a rudderless ship, with no

clear course charted for the future. Everybody hoped with a team headed by Dr ManmohanSingh at the helm, economics would dominate politics. But, unfortunately, the signs increasingly

indicate the opposite . That is not something the market appreciates. It makes the market rather

jittery. The well-known practitioner of the dismal science of economics, Prof Bibek Debroy, puts

it well: "In these days of theDa Vinci Code and anagrams, that an anagram for the "UPAgovernment" is " Repugnant Move" just about sums up the market perception of the Government

role."

(The author is Professor of Finance, Indian Institute of Management-Bangalore, and can be

contacted at [email protected]. The views are personal and do not reflect that of his

organisation.)

stock market panics when politics dominates economics

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