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Stock Markets in India

During the last few years India has emerged as one of the world’s fastest growing economies. India’s stock markets grew not only in size but also in terms of product offerings. The increasing interest of foreign players in the domestic broking industry is a testimony to the stock market’s growth. The stock market in India has also received a thrust from rise in business transactions over the years, sharp drop in brokerage fees, and transaction costs, launch of a slew of new products, and a robust regulatory environment. The broking industry in India seems to be coming of age as more broking houses are getting listed and stock exchanges are becoming de-mutualised and corporatised. The equity broking firms have also diversified to other businesses like investment banking and wealth management, which was once the turf of foreign players of international repute.

Reform-led growth of Indian stock markets

Over the years several measures — electronic trading system, dematerialising securities, corporatising and demutualising exchanges, settlement through clearing corporations, trading in derivatives — have been taken to expand the stock markets. During the last one year, the Securities and Exchange Board of India (SEBI) introduced some major policy initiatives; for instance, it made grading of IPOs mandatory; it introduced mini contracts in equity indices and option contracts with longer life tenure, and recently, it permitted short selling, and securities lending and borrowing and trading in currency futures. SEBI has invited proposals from various exchanges for setting up an exchange for small and medium enterprises (SME). SEBI is the regulatory authority for stock markets in India.

The broking industry is poised for a quantum growth in the medium to long term because the economy is moderately strong; equity culture is proliferating; new products are hitting the markets; there is wider integration with global markets, and more thrust on reforms. The Indian stock markets’ long existence, for over almost oneand- a-half centuries, has enabled the broking industry to not only absorb and adopt new opportunities but also seamlessly improvise their systems, which has paved the way for its growth and diversification.

Proliferation in equity culture

Due to the reforms mentioned before, and due to greater regulation in the capital market, the proportion of shares and debentures in the total financial savings of the household sector has increased. In FY08, savings in shares and debentures accounted for almost 10.5% of the total financial savings of households as compared with just 5.1% in FY06. In FY08, the savings in shares and debentures rose to over 1.6% of the GDP.

The household sector’s savings, which includes both physical and financial assets, accounted for 23.8% of the GDP; out of this 23.8%, financial assets had an 11.3% share and physical assets had a 12.5% share. The financial assets comprise currency, deposits, shares and debentures, pension funds, mutual funds, life insurance funds et al.

During FY01 to FY08, the per capita income in India doubled to Rs 33,283 from Rs 16,688. The per capital income in real terms at constant prices (1999-00) was higher by 45.5% at Rs 24,295 as compared with the per capita income of 1999-00.

According to a study by the National Council for Applied Economic Research (NCAER), the number of households that fall under the medium and high income bracket is set to go up steadily in the next two years, while the number of households that fall in the poor income bracket is set to recede. In FY08, household income levels for Mumbai and Delhi crossed the Rs 400,000-mark, which is equal to twice the estimates for all-India GDP per capita, and roughly equivalent to China’s 2007 per capita income levels. Moreover, the income distribution has changed dramatically in certain cities. In Surat, for instance, the medium income population more than doubled during 2004-05 and 2007-08 and in Lucknow, Jaipur, and Nagpur, the growth in number of high income households was the fastest.

Sensex goes on a free fall in 2008

During CY03-CY07 the Indian equity markets experienced impressive growth and grew by leaps and bounds. The strong momentum in the equity market was in line with the robust economic growth witnessed during the last few years. Foreign inflows into the country swelled to more than Rs 2,301 billion in stock markets during FY04- FY08, which was equal to almost 80% of the net cumulative FII investments in India at the end of FY08, as India turned into one of the fastest growing economies across the world, and India Inc reported robust performance year after year. The phenomenal surge in FII investments and stock indices reflected the future value and quick growth opportunities in India.

In FY08, the average market capitalisation of companies listed on Bombay Stock Exchange (BSE) was Rs 53.5 trillion, almost 9% more than the country’s GDP during the same year. The market capitalisation to GDP ratio rose from just 21.9% in 2002-03 to over 109.0% during 2007-08. The surge in activity and participation at the Indian stock exchange reflects in the total turnover to GDP ratio shown in the table below. The foreign investment in India grew more than 24 times during FY03 to FY08. The sharp surge in market capitalisation-to-GDP ratio and the continuous boom in stock market were synchronous with the robust GDP growth that the Indian economy witnessed. The number of companies listed on the stock exchanges increased to 1,381 in FY08, up by around 68% as compared with FY03.

In terms of movement of stock indices, the trend set in 2008 turned out to be a sharp contrast to the trend seen in preceding years as volumes dropped amid global sell-off triggered by the crisis in the global financial markets and the fall out of major banks across the world. After climbing up to 21,206 on Jan 10, 2008, the Sensex went on a free fall of more than 50% and ended the year at 9,903.

India Inc looks towards public capital markets for funds

Riding high on the wave of economic boom, India Inc opted strongly for the initial public offer (IPO) route to raise finances during FY05-FY08. The burgeoning size of the Indian IPOs increased the borrowers’ access to capital, offered more efficient prices, and increased opportunities for risk sharing.

The bull-run in India’s capital markets encouraged a shift in financing from banks to public capital markets; there was a surge in large IPOs worth few billion dollars in the last few years. In FY08 larger issues made way into the market, and more than 30 mega issues (issue size of above Rs 3 billion) hit the stock exchanges, including the Rs 115.63-billion ($3 billion) Reliance Power IPO. In FY08, 124 public issues (including rights issue) garnered Rs 870.29 billion while in FY07 the same number of issues could collect only Rs 335.08 billion. The average size of the issue was Rs 7,020 million in FY08 as compared with Rs 2,700 million in FY07, which was an indication of both the growing size as well as the attractive valuations earned by Indian companies.

However, the scene changed drastically in 2008, when on an average, only three IPOs per month were raised as compared with eight IPOs in a month raised during 2007. Moreover, few large high profile IPOs like that of Emaar MGF, Wockhardt Hospitals withdrew or failed during the year.

FIIs sell equity worth Rs 477 billion during FY09

Foreign institutional investments (FII) increased significantly during FY03 and FY08, especially in FY04, when the surge in net foreign investment in the equity market reached a record Rs 458 billion as compared with just Rs 27 billion in FY03. The net FII investment was at an all-time high of Rs 662 billion during FY08; to reach a cumulative investment of Rs 2,914 billion. During the same year, the FII turnover on the capital market segment of NSE was close to 17.9% of the total market turnover.

However, an abrupt reversal in trend was observed in 2008, as the world’s financial woes widened and so did the credit crunch. The failure of large banks worldwide prompted large outflows from almost all emerging markets including India. India registered a net outflow in equity investments by foreign investors way back in FY99, when approximately 5% of the cumulative net investment by FIIs was liquidated. After ten years, the Indian markets currently are witnessing some FII outflow due to global recession and a depression worse than the Great Depression that hit the developed countries in 1920s. In FY09, the FII investment was negative at Rs 477 billion, whereas the number of registered FIIs increased by 316 (24%) to 1,635 and the number of registered sub-accounts increased by 1,051 (27.4%) to 5,051.

As the FIIs shied away from the Indian markets, the domestic institutional investors comprising banks, domestic financial institutions, insurance and mutual funds came into the picture and purchased huge amount of shares sold by FIIs throughout 2008. The data on the investor category-wise turnover shows that the domestic financial institutions bought aggressively in 2008 when the FIIs were selling heavily. The FII turnover on the capital market segment of NSE was close to 17.9% of the total market turnover.

Investors poorer by Rs 167.4 billion on each trading day

The Indian markets witnessed a fantastic year of business in 2007 when the market was at its bullish best and cash counters were ringing across the emerging markets. The financial markets were on an upswing and the premier stock exchanges recorded a total turnover of Rs 25,123 billion in Oct 2007 as compared with a turnover of Rs 9,011 billion in Jan 2007.

However, there was a reversal in trend in 2008, when the markets entered one of the worst bearish modes seen in recent times. During this year, the markets were characterised by high volatility following a decline in volumes and consequent decrease in liquidity. The financial markets in India lost nearly Rs 41,190.1 billion in 2008, as they mirrored the global trend. Even though the crises had originated in the US and other European countries the slowdown did mar the Indian markets. Consequently, on an average, the financial markets in India lost close to Rs 499.8 million for every trading minute in 2008, which made investors poorer by Rs 167.4 billion on each trading day of 2008. The ripple effects of this loss were seen in the rising numbers of illiquid securities and the sharply decreasing traded turnover. The number of illiquid securities rose to 1,923 in Feb 2009 as compared with 1,641 in July 2008. The rise in the number of illiquid securities is a concern as it mirrors the fact that more than half of the securities are illiquid.

The volume of shares traded declined by 25% and to a certain extent this decline could be attributed to the fall in stock prices. In 2008, the number of shares traded declined by just 2.83% to 222,726 million as compared with 2007. The volume of shares traded fell by 12.1% on the BSE and it climbed up by 3.4% in the National Stock Exchange (NSE). The NSE not only garnered almost the entire market share in equity derivatives but also increased its market share in the cash market segment. A closer scrutiny of the equity cash and equity derivative segments of the stock exchanges indicate that in Dec 2008 the derivative market of BSE was almost deserted as the exchange witnessed a total traded turnover of just Rs 0.3 billion as compared with a traded turnover of Rs 222.8 billion in Jan 2008. In the cash market segment also, the market share of the BSE fell from 29.3% in Jan 2008 to 27.5% during Dec 2008. Investors are bound to trade in markets that are more liquid and exit the illiquid markets during liquidity crisis, and the investor behaviour in the derivative segment of BSE probably follows this reason.

Volatility of international stock market indices during 2007-08

The movement of stock indices to a certain extent depends on market sentiments — one of the indicators of volatility, as increase and decrease in volatility is always a signal of extent of fear within the sentiment. The volatility in stock markets is high when fear is high. The volatility index generally starts rising during times of financial stress and decreases as investors become complacent. The rise in volatility index also reflects the panic demand for puts as a hedge against decline in stock portfolios; therefore, there is less need for portfolio managers to buy puts during a bull run.

The stock markets across the world remained turbulent during the whole of 2008 and closed the year with significant declines, and high volatility. During FY08, China recorded high volatility as compared with other BRIC countries (See table below). The volatility increased sharply in the second half of FY08 (Oct–Mar). In fact for almost all the countries, volatility almost doubled during the second half of FY08 as compared with the start of the year.

Brokers cautious about client funding

The dismal performance at the stock markets and the steep fall in trading volumes was a result of liquidity issues, deleveraging of markets, and the credit crunch coupled with the most severe bear market in recent history. Due to the current bearish phase, revenue from related businesses in equity broking is also expected to have taken a huge hit. The uncertain events and rise in uncovered debits have turned brokers extra cautious in terms of lending without security.

According to the data on the NSE, the institutional clients accounted for a major chunk of the amount funded during CY08. The amount funded through margin funding accounts formed close to 20% of the total client funding. A margin trading agreement allows the traders to borrow up to 50% of the total money required for a stock purchase from the broker at a pre-agreed rate of interest (18-20%).

Client funding by brokers on the NSE, which comprises of temporary margin, margin trading, and funding for institutional and non-institutional clients, declined since Jan 2008. The total amount funded in Dec 2008 was Rs12,829.5 million, down by about 55% as compared with the amount funded in Jan 2008. The phasing in of the bear market from Jan 2008 suggests that the declining trading activity, low market volumes, liquidity issues, and credit crunch had caused a ripple effect and resulted in a decline in client funding.