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Last Updated: Tuesday, 20 December 2005, 16:33 GMT
Why India's stock markets are rising

By Alam Srinivas
Business editor, Outlook magazine

Stock brokers at the Bombay Stock Exchange
Most of the money has come in from foreign investors
India's stock markets have been on the rise since May 2004.

The benchmark Bombay Stock Exchange (BSE) index, the Sensex, has shot up by over 100% to cross 9,000 points for the first time in its history.

Buyers, like the aggressive foreign institutional investors who have pumped in more than $10bn this calendar year, are excited about India's growing economic strength.

Others are convinced that the economy is fundamentally strong and believe that the country's financial markets are more mature than those of other emerging economies.

More importantly, unlike in the past the regulators think this time there is no scam that is lurking on the horizon.

Puzzle

Over the past four months, the Sensex has risen and fallen only to rise again, confounding the experts.

The questions that are being asked are:

  • Does anyone know why the Sensex is going up?
  • Are the policy-makers and regulators talking up the markets?
  • Should small investors risk a dive into the seemingly-attractive equity pool?

When the Sensex began its dizzying rise in May 2004, there were a few positives.

The economy was - and is still - growing at 8% every quarter, the foreign exchange reserves were at high levels of more than $100bn and corporate earnings were healthy.

In addition, two reputed reformers, Finance Minister P Chidambaram and Prime Minister Manmohan Singh, who ushered in economic reforms in 1991, were in decision-making positions.

Liquidity

Over the next few months, the market discounted negatives like the tsunami, floods in major cities such as Madras (Chennai), Bangalore and Mumbai (Bombay), high global crude prices and the 2005 budget that was focused more on welfare schemes for the poor and less on reforms.

A view of Mumbai's stock exchange
Good times at the Bombay Stock Exchange
But as the months passed by, it was clear that macro-economic fundamentals - such as agricultural growth and industrial production - played a minor role in the Sensex's rise.

Core sectors or infrastructure were not doing well with low quarterly growth rates.

The feeling in the market was that the reason the Sensex was going up at a frenetic pace was due to huge money flows from foreign and domestic investors.

Globally, institutional investors seek to invest in emerging markets.

New funds - from Japan and west Asian nations - are eyeing the attractive returns in emerging nations, including India.

This is why all the emerging markets have performed well in the past two years - some better than India.

Domestic Indian funds have raised an estimated 190bn rupees ($4.2bn) between January and November this year to buy shares, much of this from small investors.

In 2004-05, according to data released by the country's central bank, households' financial savings comprised 13.7% of GDP; of the gross financial savings, a mere 1.1% was invested in shares and debentures.

Another 0.4% of the savings went into mutual funds.

Economists say that only 2% of India's population invest in equity.

Economy strong

Many believe that the Sensex is proof of India's economic strength.

Most global reports have indicated that the Indian economy will be larger than the developed ones, except China, in the next few decades.

Policy makers and regulators seem interested in a strong market, only to use it as a reason to prove that their policies are being viewed positively.

But this logic falls flat when one realises that, unlike the Dow or Footsie, less than 5% of Indian companies are listed on Indian stock exchanges.

The Sensex comprises 30 of those stocks.

A better indication of the health of India's economy would be the collective movement of the 2,500 shares that are regularly traded, rather than the Sensex.

If the BSE index has to move at higher levels in the near future, retail participation has to go up.

This may be one of the reasons why experts - policy makers, regulators, institutional investors and economists - are making efforts to woo the small investors.

But there is an inherent danger in this.

In 1992 and 2000, the bull runs in India were halted by un-nerving scams, hurting small investors the most.

Logically, the Indian market can also crash if the money supply dries up.

In the case of foreign funds, it can happen if the US interest rates keep going up, there is a global slowdown, or a scam surfaces in any of the emerging markets.

Thus, the small investors, who invariably lose their shirts in case of a crash, need to be careful.

SEE ALSO
Outsourcing 'to earn India $60bn'
12 Dec 05 |  South Asia
India backs Asian free trade area
12 Dec 05 |  South Asia
India set to lure more investors
27 Nov 05 |  Business
Indian stock market at new peak
20 Sep 05 |  Business
Investors ride Indian stocks wave
19 Sep 05 |  South Asia

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