Increasing disconnect between economy and stock market

The country’s capital market is increasingly influenced by global developments because of the active participation by FIIs and big corporates’ growing appetite for global borrowings. This is leading to a widening disconnect between the stock market and the economy, which is expected to grow at more than 9 per cent in coming years.

The traditional view is that stock markets are barometers of the economy. It is expected that the markets and their indicators, in the form of indices, reflect the potential of the corporates listed on them and, in the process, the direction and health of the economy. If a country’s economy is performing well and expected to grow at a healthy rate, the market is usually expected to reflect that.

But globalisation has changed all that. The day trader in Guntur or Kamrup has to worry about sub-prime foreclosures and yen carry trades. He has to read the lips of the Chief of European Central Bank and understand the nuances in the speeches by the Chairman of the US Fed.

Unfortunately, though, this globalisation seems to be a one-way street. We are integrated with the global market and influenced by developments in Alaska or Adelaide but our market has little influence on global markets. We do not see news reports that the Dow Jones has been affected by a Mumbai melt-down or that the FTSE was impacted by political drama in New Delhi.

Hence, our market’s tango with others is extremely dangerous, particularly for the financial illiterates who are large participants in day-trading activities.

The market is still skewed, the top 10 securities constituting 23 per cent of the turnover and 25 securities constituting 42 per cent in June (NSE News, June 2007).

The share of top 10 trading members was 25 per cent and that of top 25 members was 44 per cent (NSE News).

Table 1 provides the recent data for the turnover in the market for different categories, such as foreign institutional investors and domestic institutional investors (FIIs and DIIs). The role of FIIs is significant from the point of view of gross turnover, as seen in Table 1. It shows that FIIs constitute an important segment of trading in this skewed market and their ‘sells’ in August were higher than their ‘buys’.

Category-Wise Turnover

It is estimated that more than 30 per cent of the gross activity is due to FIIs and around 15 per cent due to MFs, etc.

It seems that MFs are net buyers in August, thereby cushioning this system, which is quite volatile due to FII sales. The small, or individual, investor is caught in the midst of all this.

A significant portion of day-traders are individual investors and they may not have full information on global issues affecting the market through FIIs.

Also, while an individual in the US or Europe can diversify his portfolio in New York and Mumbai, one in India can only buy in India. Of course, he can invest up to Rs 100,000 in the global market through specified banking channels, but this scheme has not been popular given the interest rate differential between India and other markets.

Given this asymmetry, global sneezing may lead to an Indian cold but even Indian typhoid has little effect on global participants. It is thus clear that the integration that has happened in the stock market is just one-sided.

Coupled with this is the enthusiasm of Indian corporates for global money. In the last two years, the appetite of large corporates for external commercial borrowings has been huge. Table 2 indicates the role of FII /FDI and ECBs during last two years.

Global money

We find from the RBI data that the role of external commercial borrowings by corporates and FDI/FII were significant during 2005-06 and 2006-07. ECBs showed an additional inflow of more than $13 billion and, interestingly, the top 10 companies, such as Reliance Petroleum ($2 billion) Reliance Communications ($1 billion) Tata Steel ($0.8 billion) Reliance Industries ($0.8 billion), and Reliance Energy ($0.8 billion) constitute more than 30 per cent of the ECB approvals/registrations in the later period.

This shows that corporates are increasingly looking at external sources due to lower cost and, to that extent, developments in the global markets affect their ratings. Major global borrowers also have considerable impact on our stock indices.

An interesting situation has arisen in the development of our capital markets wherein they are significantly influenced by global developments because of the active participation by FIIs, and, at the same time, big corporates are showing an appetite for the global borrowings and not for domestic debt, because of the interest rate arbitrage.

In such a situation we find that the stock market is getting increasingly disconnected from the domestic economy, which is expected to grow at more than 9 per cent in the years to come.

Already, there exists a wide divide between Government and Society and now there is a new disconnect between the economy and the stock market.

Individual day-traders need to exercise caution and not ignore a mild cold in London. However, the Finance Minster need not lose sleep because of the rise or fall of the the index since it is due to a chill in London or Tokyo and not in our economy.

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