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Business Commentary/ R C Murthy

Of peaks, pits and battle of wits

The recent surge in share prices was as unexpected as the subsequent fall. While the crash was in the wake of sudden developments along the Line of Control in Kashmir, the surge that preceded the crash was entirely due to exogenous reasons.

It is now a battle of wits between the foreign institutional investors, local investment institutions and speculators.

The FII blitzkrieg that brought in some $850 million or roughly a tenth of a total $9.5 billion FII investment so far, caught the otherwise agile local operators on the Bombay Stock Exchange unawares.

Normally, aware of the timing of the FII buy and sell operations, these operators manipulate the market before hand to make a quick buck. This time, the FII bull-run bypassed the local operators.

The BSE 30-share Sensitive Index was not a true reflection of the investment frenzy. The Sensex surged past the 4,100 level, but did not go beyond the Harshad Mehta-managed peak of 4,200 in early 1992.

Well, the FIIs were least concerned over the Sensex movement. Their objective is obviously to pick as much stock at as low a price as possible.

The interesting aspect is the FII attitude to exposure in emerging markets. They ignored political instability in New Delhi and brought in massive sums. They seemed to have not bothered which political party comes to power. Business would in any case be as usual -- that was their thinking. Whoever comes to power, there would be forward movement in economic reforms.

It is only a question of pace. When it came to disturbances along the LoC, the FIIs demurred. Would there be a war with Pakistan? A prolonged war would mean an adverse impact on the country's economy and possible resort to tighter exchange controls, affecting free movement of FII funds.

The jitters abated only after partial stabilisation of the Kashmir situation and the government reiteration of limiting action within the borders.

It is clear the FIIs behaved differently from others market players in the context of their response to the political situation.

Even with respect to investment, their attitudes and behaviour are different. Their perspective being global, the FIIs look at comparative performance of the markets.

The improvement in Asian economies' performance may be marginal. If the rest of the world decelerated or did not keep pace with others, even that marginal Asian improvement stands magnified, warranting a readjustment of FII portfolios. And, if the investment strategists looked at these changes positively, as a beginning of the long-term growth cycle, the need for realignment is all the more warranted.

Even within the FIIs, the capital movers are of different hues and with varied objectives. At one end of the spectrum are hedge funds (loosely called hot money) trying to make a quick buck playing havoc everywhere; at the other end are long-term investors like pension funds who invest with a set of long-term objectives and look for a reasonable return. They are guided by in-house investment strategists, who review constantly the markets worldwide.

Such a review recently catapulted Asia to the top of emerging markets. Asia's growth projections were revised upwards following a turnround in countries hit by the Asian contagion earlier. South Korea is projecting to grow at four per cent this year against negative growth last year. So too is Thailand.

India's growth rate at four-plus per cent is postulated lower than that of last year. Viewed from industry's performance in April, the sights are being set at a higher GDP growth this year. This improved Asian performance, as the FIIs perceived, called for greater weightage to Asia in their investment portfolio.

The immediate cause, however, is the rush of investible funds arising out of Wall Street's outstanding performance and the peaking of share values in the US. Investors there were left with large liquidity and investment institutions had to find avenues for its remunerative deployment.

Fortunately, those were reasonably long-term funds brought into the country not by fly-by-night operators but by well established FIIs like Capital International, Morgan Stanley and Jardine Fleming, the three accounting for three-fourths of some Rs 35 billion.

What if they are hedge funds? Now that India opted to integrate with the global economy, it should be ready to accept the virtues and evils of capital flows, a major force of the world economy now.

The liquidity flow seemed to have a favourable impact in the sense that institutions like the Unit Trust of India could sell and keep enough cash to meet the dividend outgo. Thus, the UTI moderated the Sensex surge.

But looking at the experience of south-east Asian countries like Thailand and Indonesia, where hedge funds played havoc with their economies, there is an urgent need to build enough local counter-weights to absorb the floating stock and moderate the fall.

These bulwarks can be built first, if only the domestic savings are high and secondly, if the bulk of those savings are channelised into equity. At 27-28 per cent of GDP, domestic savings are fairly high. But Thailand has had even greater savings and yet was a victim to the machinations of hedge funds.

But the Indian economy is far bigger than Thailand and over a period of time, India should be able to bring a strong local institutional structure. The sooner we did that the better.

R C Murthy

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