Stock market sinks under own weight

The Big Story

To understand why the stock market went up from 13,984 on August 21 to 18,716 on October 17, one has to know how much money there was to be made in the Indian market, one of the friendliest markets in the world for foreigners. Unless we understand the rise, we will not understand the fall. If an FII invested $100 million, it would make a profit of $50 million, which is not unheard of, considering the way the market was vaulting and so were the stocks. So the effective investment of the FII remains only $50 million. It then leverages this further because for one dollar it gets Rs 40, and since it can play five times the amount in the derivatives segment where only 20 per cent margin is necessary, it can for every dollar take a position of Rs 200. So, with hardly any investment, it can mint money as leveraging is the name of the game. Compared to this the mature markets give just four to five per cent returns. The Indian markets had become as exciting as a casino. TAX FREE FIIs can repatriate their dollars tax free. HOW This is how stocks moved up and gave returns: The present rally in the stock market actually started around August 2007. From August 21, 2007 the Sensex went up from 13,989 to 18,716 on October 17, giving 34 per cent returns to those who played on the index. During this period the top 10 stocks among the 30-stock index that makes up the Sensex gave the following returns: Reliance Energy, which went up from Rs 692 to Rs 1,762 or a return of 155 per cent, followed by Tata Steel from Rs 546 to 869 (59 per cent), Reliance Industries from Rs 1,747 to Rs 2,690 (54 per cent), Maruti from Rs 768 to Rs 1,174 (53 per cent), Reliance Communications Rs 484 to Rs 737 (52 per cent), Hindalco from Rs 136 to Rs 198 (45 per cent, BHEL from Rs 1,590 to Rs 2,283 (44 per cent), ONGC Rs 790 to Rs 1,130 (43 per cent), L&T Rs 2,309 to Rs 3,294 (38 per cent) and NTPC Rs 160 to Rs 221 (38 per cent). HOW THE FII MONEY POURED IN * From January 1, 2006 till October 18, 2006 an amount of Rs 23 crores was brought in by the FIIs. * Between January 1, 2007 to October 2007 the amount brought in was Rs 74 crores. * But between October 1, 2007 to October 17, 2007 the FIIs had brought in Rs 23,000 crores, which is more than all the money they brought in the first 10 months in 2006, or in the first nine months of this year. HOW THE STOCKS ROCKETED AND GAVE UNHEARD OF RETURNS The rally in the stock market started around August 2007. From August 21, 2007 the Sensex went up from 13,989 to 18,716 on October 17, giving 34 per cent returns. During this period the top 10 stocks among the 30 stocks that make up the Sensex and that gave the most returns in descending order were: Reliance Energy, which went up from Rs 692 to Rs 1,762, or a return of 155 per cent, followed by Tata Steel from Rs 546 to 869 (59 per cent), Reliance Industries from Rs 1,747 to Rs 2,690 (54 per cent), Maruti from Rs 768 to Rs 1,174 (53 per cent), Reliance Communications Rs 484 to Rs 737 (52 per cent), Hindalco from Rs 136 to Rs 198 (45 per cent, BHEL from Rs 1,590 to Rs 2,283 (44 per cent), ONGC Rs 790 to Rs 1,130 (43 per cent), L&T Rs 2,309 to Rs 3,294 (38 per cent) and NTPC Rs 160 to Rs 221 (38 per cent). PARTICIPATORY NOTES (PNotes) Among these FII, the money that was doing the fuelling also came through participatory notes (PNotes). As Sebi said in its background to the proposals it had issued for discussion on how it would like to regulate the participatory notes: The number of foreign institutional investors (FIIs) and sub-accounts issuing participatory notes increased from 14 in March 2004 to 34 currently. The value of the PNotes outstanding, which was Rs 31,875 crores in March 2004, had grown to Rs 3,53,484 crores in August 2007. This represents 51.6 per cent of the assets under management by these FIIs and sub-accounts (earlier it was just 20 per cent). In fact, during the Ketan Parekh scam it was said that the money that he was playing with for pushing up stocks artificially was that which came through PNotes through the Mauritius route. SOME FAVOURITE STOCKS WHERE PNOTES INVESTED Amongst the stocks on both the BSE and the NSE in which PNote investments are the highest in percentage terms are UTI Bank, now known as Axis Bank, India Bulls Real Estate and India Bulls Finance, HDFC and IDFC, Financial Technologies, Jai Prakash Associates, Saregama India, PNB, ICICI Bank and Tata Steel. According to Mr Arafat Saiyed, a research analyst with Karvy Stock Broking Ltd who prepared most of the tables on this page, value wise PNote holdings are highest in ICICI Bank at Rs 11,124 crores of the total FII holding of Rs 50,168.18 crores, followed by HDFC at Rs 9,504.90 crores of a total FII holding of Rs 53,445.17 crores, and in Axis Bank Rs 6,929 crores of a total FII investment of Rs 10,169.75 crores. The total FII holdings value-wise among the Sensex and Nifty stocks are highest in ICICI Bank at Rs 50,168 crores followed by HDFC Rs 53,455.17 crores, then Tata Steel at Rs 11,306.89 crores, Axis Bank Rs 10,169.75 crores and IDFC Rs 9,545.75 crores. The rest of the scrips are also substantial, but lower that the top five. The market boom has, in effect, been its doom. The run-up was so unprecedented and overwhelming that it had to attract attention. Curbing PNotes is just one of the measures that can stop this speculative inflow into the Indian stock markets. The PNotes Syndrome Participatory notes are like contract notes. An entity that wants to invest in the Indian market but wants to remain anonymous can invest through an FII or its sub-account which is registered with the Securities and Exchange Board of India (Sebi). FIIs registered with Sebi and their sub-accounts can issue, deal, or hold PNotes. The underlying security against these contract notes are listed on any Indian stock exchange. The PNotes fall in the category of offshore derivative instruments (ODIs), which include equity-linked notes, capped return notes etc. FIIs issue these notes to these investors who are primarily hedge funds, giving them details of the stock they can invest etc. The investors can deposit the funds in an overseas branch of the FII. The name or the face of the ultimate investor is not known as is required under Sebi’s know-your-client norms. WHY ANONYMITY This is a million-dollar question to which there is no convincing answer. Some say that foreign investors prefer PNotes because it is faster to invest. Registering with Sebi, they say, is a cumbersome process. “This is not true,” says Sanjay Sachdev, country manager, Shinsei Bank. “Registration is given within four weeks in India. In other countries it is much longer. In Singapore it takes two to three months. What Sebi has done is a good thing, it brings transparency into the market.” The other explanation is that behind PNotes is allegedly the money of politicians and bureaucrats. This is called round-tripping, where the money goes out of the country and comes in through PNotes. Sebi’s bullfight Sebi’s proposal to curb the unlimited flow of participatory notes was literally like a red rag to a raging bull. It acted as a speed breaker to the irrational, inexplicable leapfrogging of the Sensex, devouring thousand points in shorter and shorter time. Most of all, it has brought transparency and will hopefully lead to a stable, healthy market. WHAT ARE THE PROPOSALS * FIIs and their sub-accounts cannot issue participatory notes with derivatives underlying them. * Sub-accounts of FIIs cannot issue any PNotes and have to liquidate them in 18 months. * The values of the PNotes cannot exceed 40 per cent of the assets under custody of the FIIs (excluding derivatives). * PNotes investors can come in if they register with Sebi. WHY THE PROPOSALS The stock market had got to a point where nearly 51.6 per cent, or Rs 3,53,484 crores, consisted of PNotes of the total investment by FIIs till August 2007. Three years ago it was just 20 per cent. This represents what is called "hot money": money that can be taken out of the country any time. This is a dangerous situation for any country to be in, not only its stock market. Added to this danger were the challenges faced by the Reserve Bank of India in tackling these huge inflows by trying to mop up dollars by pumping in rupees. This results in putting more rupees into the market, which aggravates inflationary pressures. The rupee also becomes stronger as the demand for rupees goes up. This creates a whole set of other problems for sectors like exports and IT. Adding to this is the possibility of funds coming in for money laundering.