A Sensex crash of 500 points in a matter of a few minutes, shows how hollow the Indian market is, as Moneylife has been pointing out for years now
Sometime just before 10 in the morning on Monday 20th June, on a simple rumour that India would restart talks on a tax treaty with tax haven Mauritius, stocks went on a freefall. At 10:00AM, the Sensex was at 17,737, a modest decline of 134 points from the close on Friday, 17th June (17,870). In the next three minutes, the index had plunged by another huge 170 points. Buying came in and the Sensex was up 80 points in the next minute or two and then suddenly a wave of fresh selling sent the Sensex crashing by 330 points in just 3 minutes of trading. The Sensex was down by 500 points from yesterday's close, literally in minutes-when a movement of 100 points has been hard to come by for days together.
The same has been the story during the rallies as well. On 13th April, the Sensex rallied by 626 points for no reason at all, within an overall trend of weakening stock prices, thanks to massive headwinds that the market and the economy are facing. From the next day again, the market started drooping.
What makes the market so bipolar? Well, it is indeed in the nature of the stock market to be volatile-sometimes without any reason. But there is another big reason for the Indian market to behave in such an extreme manner. It is the hollowness of the Indian market, which has become a play for options traders and institutional investors.
Moneylife has been pointing out that the Indian market is narrow, shallow, illiquid and concentrated in the hands of a few individuals located in a few centres-nearly 20 years after India embarked on financial liberalisation. We expected a spread of equity cult, but only a few thousand investors possibly trade on the cash market. The cash market volumes on the NSE (National Stock Exchange) and the BSE (Bombay Stock Exchange) have been dwindling rapidly, replaced by volumes in stock and index options.
The NSE records an average daily turnover of over Rs10,000 crore in the cash segment and over Rs80,000 crore in the futures and options (derivatives) segment, while the Bombay Stock Exchange (BSE) records a daily turnover of over Rs3,000 crore in the cash segment. While these numbers are much higher than what they were a decade ago, they are misleading. In the derivatives segment of the NSE, only a few lakh clients trade, of which 90% of trading is done by about 20,000. Indeed, according to the data presented by the minister of state for finance Namo Narain Meena, in response to a question in Parliament last year, only 2,188 investors accounted for 80% of derivatives turnover in the three-month period from April 2010 to June 2010. Just 537 investors accounted for 70% of trading; 223 investors accounted for 60% of trading—of which over half were proprietary brokerage firms. And a massive 50% of trading in NSE's derivatives trading turnover, the main pillar of the Indian stock market system, came from just 106 investors of which 58 were proprietary traders!
According to the D Swarup Committee report on investor awareness and protection, India has 80 lakh investors (who invest in debt and equity markets, either directly or through mutual funds and market-linked insurance plans). This official figure also represents a sharp decline from the two crore (20 million) investor population, claimed in investor surveys commissioned by SEBI (the Securities and Exchange Board of India) in the 1990s.
The fact is that the Indian market is extremely hollow—which does not seem obvious on a normal day. It is only when there is an external shock and prices decline precipitously that one realises that there are very few natural buyers or arbitrageurs and hedgers. Conversely, don't be surprised if one of these days we see an eye-popping 600-point rally. On that day, there would few natural sellers-or arbitrageurs and hedgers.
The biggest problem with the Indian market—and this is something
policymakers don't recognise—is that there are very few large long-term players.
Domestic institutions have not grown to stature that they can play shock absorbers to a sudden cascading decline. For a variety of reasons, neither mutual funds nor insurance companies have grown to a level that they can step in during a steep decline or sell when prices suddenly rally sharply. Policymakers hoped in the early 1990s that mutual funds would channel retail savings and emerge as large long-term players. In the early 2000s, it was hoped that the life insurance companies would come to play that role too. But both these businesses were allowed a free run with the kind of business practices which did not exactly serve the interests of retail investors. A regulatory backlash ensued, which first ensured that mutual funds were hobbled and then the insurance companies were hit hard. Suddenly, it seems that there are too many players with shaky business models in a floundering sector. We cannot see this changing soon and so we will remain in the grip of wild swings caused by a few large trades. Get used to many flash crashes and roaring rallies.
We expected a minor rally before a decline, but the decline happened without a minor rally
The domestic market witnessed mayhem among blue-chip stocks today, settling with deep cuts on reports that the government may review the double taxation treaty with Mauritius, a major channel of funds into India. Stock-specific news also contributed to the slide.
The market opened with minor gains, with investors cautious due to concerns over the possible ripple-effect of the debt crisis in Europe. The Sensex resumed trade at 17,925, up 54 points from its previous close and the Nifty was six points higher at 5,372. The opening on the Sensex was its intra-day high and the Nifty scaled its high soon after, touching 5,377.
But the market soon plunged into the red on rumours of a possible default on loan repayment by promoters of GTL. Talk about a likely review of the double taxation avoidance agreement with Mauritius also added to the woes, pushing the indices to the day's low in the first hour of trade. At the intra-day lows, the Sensex dived 557 points to 17,314 and the Nifty retraced 170 points at 5,196.
The ADAG pack-Reliance Communications (down 8.35%), Reliance Infrastructure (down 6.16%), Reliance Capital (down 5.06%) and Reliance Power (down 4.46%)-were hammered down after the announcement on Friday that RCom and Reliance Infra will be replaced on the Sensex by Sun Pharma and Coal India from August.
The market bounced back from the day's low and was range-bound in subsequent trade, ending sharply lower. The Sensex closed at 17,507, a huge 364 points drop and the Nifty finished at 5,258, a 109 points slump.
These closing lows on the Sensex and the Nifty were last seen on 11 February 2011. The market has broken recent bottoms and has reached the level touched four months back. The indices are set to fall further with no immediate support in view. To know where the market will head in the next few days watch for tomorrow's move. If today's lows hold, we can expect some stability.
The advance-decline on the National Stock Exchange was a dismal 153:1281.
The broader indices suffered more. The BSE Mid-cap tanked 3.18% and the BSE Small-cap declined 3.26%.
All sectoral gauges settled lower. The BSE Realty index (down 4.16%) was the top loser. It was followed by BSE Oil & Gas (down 3.42%), BSE IT (down 2.50%), BSE Auto (down 2.46%) and BSE Power (down 2.28%).
The top losers on the Sensex were Reliance Communications (down 7.89%), Reliance Infra (down 6.07%), Tata Motors (down 5.15%), Reliance Industries (down 3.89%) and TCS (down 3.69%). The only gainers were Bharti Airtel (up 2.35%), Hindustan Unilever (up 0.36%) and Hero Honda (up 0.16%).
Markets in Asia, which were mostly in the green in morning trade, settled mixed as Credit Suisse cut its forecast for China's growth in gross domestic product (GDP) for 2012 from 8.9% to 8.5%, citing persistent inflation, slowing growth and continued tightening as the major factors. This apart, Hong Kong Financial Secretary John Tsang expressed caution on the "unusually strong" real estate market. The discouraging situation in Europe, with the key bourses trading lower, also added to the woes.
The Shanghai Composite declined 0.76%, Hang Seng fell by 0.44%, the KLSE Composite fell by 0.27%, the Seoul Composite was 0.60% lower and the Taiwan Weighted tanked 1.22%. On the other hand, the Jakarta Composite gained 0.18%, the Nikkei 225 added 0.03% and the Straits Times rose 0.28%.
Back home, institutional investors-both foreign as well as domestic-were net sellers in the equities segment on Friday. Foreign institutional investors offloaded stocks worth Rs390.56 crore and domestic institutional investors withdrew funds worth Rs35.37 crore.
The subsidy burden has affected the valuations of state-run oil companies and consequently the interests of shareholders. The government must implement the recommendations of the Kirit Parikh Committee to completely decontrol prices of petrol and diesel immediately, as well as remove the burden from upstream companies
For the last so many years, in the name of subsidising petrol, diesel and domestic fuel like kerosene and gas for the people, the Government of India has been passing on a substantial part of the burden of oil subsidy to upstream oil companies, who have faithfully carried out the orders of their masters, by giving large discounts to downstream oil companies, thereby causing a deep dent in their profits year after year. The magnitude of the burden can be gauged from the following figures.
It can be seen from these figures that the upstream oil companies have been bearing a hefty burden of subsidy for the last several years just because the central government, which owns a majority shares in these companies, has been directing them to do so, apparently for the following reasons that have been described in the Kirit Parikh Committee report, 2010.
1. To protect poor consumers, so that they may afford kerosene for lighting which is necessary for those who do not have access to electricity.
2. To provide clean cooking fuels like LPG and kerosene at reasonable cost from the social and environmental angle.
3. To insulate the domestic economy from the volatility in petroleum prices in the world market.
Whatever is the rational for the subsidy, there is no reason to make upstream oil companies suffer in the bargain, as the sword of uncertainty already hangs over them, with the subsidy level changing with the change in international oil prices. In all fairness, the entire subsidy burden should have been met out of the budgetary resources of the government, as protecting the poor and the country's economy is primarily the responsibility of the central government and not that of the oil companies, which should be run purely on commercial lines, more so when they are part-owned by private individuals and institutions.
The three upstream companies ONGC, Oil India and Gail were fully owned by the government till 2004. The government divested a part of the equity of Gail and ONGC in February and March 2004 and in Oil India in September 2009. The shareholding pattern of these three companies as on 31 March 2011 was as under.
Since these companies are no longer fully owned by the central government, the minority share holders of these companies too have suffered on account of this subsidy burden imposed on these companies and they continue to suffer for no fault of theirs. If this subsidy burden was not forced on these upstream companies, they would have been in much better financial health, declared much higher dividends, and their valuations in the stock market would have been much higher than what they are today.
The Kirit Parikh Committee, set up to suggest a viable and sustainable system of pricing of petroleum products, submitted its report on 2 February 2010, and recommended complete decontrol of petrol and diesel, but suggested continuation of subsidy on a much reduced scale for kerosene and LPG gas, as it is consumed by the poorer section of society. Unfortunately, the Committee did not feel it necessary to exempt upstream oil companies from the burden of subsidy and it recommended mopping up a portion of the incremental revenue accruing to ONGC and OIL India from production in those blocks, which were given by the government on nomination basis, much before the New Exploration Licensing Policy (NELP) introduced in January 1999.
The Central Government has not yet fully implemented the recommendations of the Kirit Parikh Committee, except that the pricing of petrol has been decontrolled a few months back. All other recommendations are still to be implemented, which means that there is no respite for the oil companies, who continue to suffer from the uncertainty of the subsidy burden, as the international price of oil continues to be volatile for the last several months.
It is generally perceived that the government is reluctant to completely abolish the oil subsidy, more due to political than economic considerations. Whatever be the reasons, there is no justification for making minority shareholders of these companies suffer, as it amounts to oppression of minority shareholders by the majority shareholder, which is neither ethical nor legal.
Section 397 of the Companies Act provides for relief in cases of such oppression by the majority, and the oppressed shareholders can seek a suitable remedy. But here the majority shareholder being Central Government, Ministry of Corporate Affairs will not be the right forum to get this grievance redressed and the investors may have to seek suitable remedy from an appropriate court.
Another dimension to this subsidy muddle is the upheaval caused in the stock market in respect of the market price of these PSU oil companies. The electronic media is full of statements made either by government officials or the company managements on the different versions of this subsidy, which causes considerable volatility in the stock price of these companies. This artificial volatility is neither healthy for the market, nor desirable from the investors' point of view, and the Securities and Exchange Board of India appears to have not taken any steps to contain such statements.
The invisible part of the subsidy mess is the unquantifiable loss caused to the Central Government due to its not getting the right valuations for these oil companies, as the market does not appreciate the uncertainty hanging over the head of these companies, who otherwise are considered jewels in the crown and the pride of the country. The government has, therefore, been forced to defer further divestment from these companies, hurting government coffers as well.
In the interest of both majority and minority shareholders, the government should not only implement the recommendations of the Kirit Parikh Committee immediately, but also absolve these upstream oil companies from the obligation of subsidy completely, thereby creating an environment of good corporate governance in these companies in which it is the majority shareholder. If it is felt necessary, the government could levy a one-time capital charge on pre-NELP leases granted to these companies as compensation for the loss of revenue in respect of those production blocks, which were leased before the NELP was put in place. This will provide a big relief to upstream oil companies, and minority shareholders of these companies could also breathe a sigh of relief and enjoy the fruits of their investment.
(The author is a banking and financial consultant. He writes for MoneyLife under the pen name 'Gurpur'.)