THE IRRATIONAL WORLD OF STOCK MARKET-II

Is There A Bubble Building? 

N M Sundaram

IN the 14 weeks up to August 5, 2005 as much as Rs 14,000 crore were ploughed into the Indian stock market by the foreign institutional investors (FIIs). As many as 49 new FIIs were registered. 2004-05 has already seen record number of FIIs registering than ever before. The participation by the Indian institutional and retail investors was comparatively insignificant. On that fateful day July 26, when everything came to a standstill due to unprecedented rains in Mumbai while, human and material losses were massive, the FIIs were undeterred and went on pushing the Sensex up.

NOTHING DETERS THE STOCK MARKET

The same tragic day witnessed the terrible accident and fire in ONGC Bombay high threatening to disrupt vital crude oil supplies on which the Indian economy heavily depended. All productive activity came to a grinding halt and remained severely crippled for a prolonged period. The godowns and warehouses were inundated and finished goods and raw materials were destroyed causing huge losses. The pharmaceutical companies reported that their stocks of medicines worth crores of rupees were damaged and rendered waste. The small and big businesses remained paralysed. Banking and other financial transactions were badly affected, communications remained disrupted, with telephone rail, air links remaining paralysed for days. The much touted privatised electricity system failed the people and the economy miserably in their dire hour of need. But the stock market remained alive and kicking with the FIIs churning its depths for every pie in profits.

In the larger economy excepting for services, both manufacturing (excepting some select sectors like automobile and ancillaries, textiles etc) and agriculture are languishing with the latter declared to be in a crisis mode, threatening decrease in food production and consequent endangering of the fragile food security in the country. Despite all the hype in services, particularly the IT sector, it is agriculture and manufacturing that produces real wealth and it is they that are languishing. And all those who matter, including the finance minister himself, admit that the projected growth rate would not be attained.

OIL PRICE HIKE IMPACT ON THE ECONOMY

Then there is the inexorable hike in crude oil prices. India has been importing as much as 75 per cent of its oil requirements and oil consumption is increasing day by day. Commenting on the high consumption levels of oil per unit of GDP in the South East Asian countries like Indonesia, Philippines, Thailand, Malaysia (a net exporter of oil), China and South Korea, The Economist remarked“the Asian Development Bank came up with three scenarios. In the gloomiest of the three, the oil price was projected to hover around $40 a barrel throughout 2005 – enough, the bank predicted, to knock over two percentage points off the growth rate in several countries.” (August 13, 2005) As against the expected $40 a barrel, “in the first seven months of the year, the oil prices have averaged over $50 a barrel, with no respite in sight.” (Ibid) The price of crude per barrel has now touched $70 and there is no sign of its abating. For India, because of its earlier buying contracts (which are fast running out) the cost per barrel of crude works out to $54.14 in August 2005 (as against $31.86 in April 2004). This will surely adversely affect the economies of the South East and South Asian countries including India. A statement by the FICCI indicates that the oil price hike will cost an “additional outflow of Rs.55,520 crore or $12.8 billion” that will “more than gobble up the additional export income of $8 billion targeted for 2005-06.” (The Hindu – August 19, 2005)

Already because of the expected decrease in agricultural growth itself, the government has predicted a fall in the growth rate by a clear one per cent. When this was done, the steep hike in oil price was not factored.

INCREASED FII PRESENCE

What then is the basis for this stock market exuberance? As already said, it is not that the Indian corporate and retail investors are operating in the market with confidence. Their role has remained comparatively minor. The moving forces behind the irrational stock market hype are the foreign institutional investors (FIIs). This is not a chance occurrence. This is calculated and planned and compelled by circumstances since the investment avenues in the advanced industrial countries of the West - have diminished on account of appallingly low growth. The finance capital therefore comes in search of greener pastures in South East Asia. India has become a preferred destination for FII investments.

We have already given a glimpse of FII’s big involvement in the short term investment activity. The data on investments in the secondary market as published by the Centre for Monitoring Indian economy (CMIE) are revealing. The report pertaining to the capital markets indicates the dominant role played by the FIIs in the capital markets. The FIIs preferred destination obviously has been equities rather than debts. Their concentration on both buying and selling, is the very grain of speculation. This is what makes for the volatility of the stock market. 

Whereas net investments in equities for the period April 2004 to March 2005 was Rs 40, 990 crore, the net investment in debt instruments was a mere Rs 1929.4 crore. The hyper activity of the FIIs can be understood when we make comparison with earlier periods. In the year April 2000 to March 2001, the FII investment in equities was only Rs 10, 142 core and in debt a negative Rs 640.9 crore. Hence there is a fourfold increase in FIIs investment between 2000-01 and 2004-05. The total net investment by FIIs in both equity and debt was Rs 42, 920.3 crore in 2004-05 as against Rs 9, 584.2 in 2000-01.

It would be useful to better grasp the role of the FIIs in moving the Indian stock market if we make a comparison from a much earlier period, say 1998-99.

The presence of FIIs in the Indian stock market was negligible, or even negative in the earlier years. However since 2003-04 it has become dominant. This is attributable to increased financial liquidity, accompanied by shrinking of investment avenues in the developed countries. This was also when India opened up its economy wider in tune with the imperatives of financial sector liberalisation.

MISPLACED STOCK MARKET EXUBERANCE

It would be appropriate to go into a recent experience of what irrational exuberance in relying on stock market can do. The experience of the United Airlines in the US that switched over from investing pension funds in bonds to stocks gives a sordid example of what would happen if people’s savings are ploughed into the stock markets.  It is alleged that it was done on the prodding of the Wall Street that advised that it would enable value to go up and consequently it would be enough if the company contributed much less than what was contracted in the settlement with unions. The result was, the pension fund lost heavily; the obligations increased while its assets fell sharply. By the time it was brought into the open and the Airlines turned over its plans to the pension agency the shortfall was $10.2 billion. (New York Times - July 31, 2005)  The federal agency, the Pension Benefit Guarantee Corporation had to pay $6.8 billion of the projected shortfall. This is apart from the cuts in pension benefits suffered by the airline’s 130,000 employees.  This has similarly serious implication for other pension funds, including those in India.

IS THIS A BUBBLE

Is a stock market bubble building? By all accounts it appears to be the case. The present stock market euphoria is deceptive. The strange thing is that none appears to be aware of its coming, fascinated and attracted as neo-liberalisers are by the boom or the bull-run as they call it. But then the bulls and the bears manipulate the stock markets often in tandem. This is what the FIIs are doing. They have done it in the past and they will do it again. The collapse of the South East Asian economies in 1997-98 and the destruction it wrought are still fresh in memory. The culprits then were the FIIs who pushed in with big time investments and pulled them out as fast. The lesson should not be lost in India, which has its own history of stock market collapses.

(Concluded)