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Guest column/P S Subramanyam

'If RIBs could succeed in a global market, resurgence of capital markets is also possible'

This was the time when the market emerged as a major source of funds to industry. The equity culture which was lacking in its thrust earlier developed fast during the period. Within a period of 16 years, the amount of capital raised from the market rose from Rs 1.95 billion in 1980 to Rs 200 billion in 1995-96 but declined to Rs 99 billion in 1996-97. Alarmingly the decline has continued and only Rs 46 billion was raised in 1997-98.

The number of stock exchanges increased from nine in the early 1980s to 23 now. The number of shareholders and investors has increased from two million in 1980 to over 40 million, which is almost equal to the number of investors in the USA.

As a result, India ranks second in terms of investor population. The number of listed companies has gone up from 2,265 in 1980s to around 6,500 in 1997-98. The market capitalisation rose sharply from Rs 50 billion to Rs 4.72 trillion over the period 1980 to 1998.

What were the factors responsible for volatility in the market? A major factor for the current volatility and common to emerging economies is the lack of breadth in the capital market.

In fact, the high aggregate turnover in emerging markets often reflects the higher turnover portfolio of relatively small number of issues. About 80 per cent of turnover is accounted for by top 50 companies, hence the market is that much easy to influence.

The Indian stock markets have traditionally been dominated by big institutional investors like, well, the Unit Trust of India, foreign institutional investors, nationalised banks and insurance company-sponsored mutual funds.

Global factors are increasingly beginning to have their say. With the internationalisation of Indian capital market, the fluctuations in the global market or the economic situation are quickly reflected in the Indian capital market. This is in sharp contrast to the earlier protected regime. Today, the situation is totally different with funds being raised from abroad.

A few years ago, we talked only about the lessons of the east Asian miracle. Today, of course, it is the east Asian crisis that is foremost in most people's minds. I think that there is a lot we have learned from the crisis, and no doubt much more will be learned. Financial crises continue to occur, and there is some evidence that they have become more frequent and more severe in recent years.

The build-up of short-term, unhedged debt left east Asia's economies vulnerable to a sudden collapse of confidence. As a result, capital outflows, and with them depreciating currencies and falling asset prices, exacerbated the strains on private sector balance sheets and thus proved self-fulfilling.

The vicious circle has become even more vicious as financial problems have led to restricted credit, undermining the real economy. We have escaped the contagion but have to learn from this experience.

Basic economic factors have to be carefully monitored. The capital market begins to almost feel and factor in changes in the economy even as they begin. Hence it is vital to monitor capital market trends.

Secondly, I believe, of the major instruments that we lack in the market, specially in a volatile scenario, are derivatives. We have planned to start with index-linked derivatives soon and then gradually introduce the whole range of options and futures. Derivatives permit the separation and unbundling of price risks, and the redistribution of risks to those best able to manage them.

The redistribution of risks based on market prices allows a more efficient allocation of economic resources. They also tend to convert more up to date information about market conditions than the underlying cash markets. In contrast to share prices, options on shares contain implicit information about market expectations of the future volatility of share prices.

As a result, derivatives tend to increase the transparency of the underlying cash markets. Finally, the growing trading volumes on derivatives markets has boosted liquidity on cash markets. Players are more willing to invest in market segments that offer hedging instruments. In turn, increased market liquidity and higher flexibility of investors also tend to reduce transaction costs by enhancing competitive pressures in the brokerage industry, thus protecting players from paying outdated prices.

The institutional and corporate investors have always felt the need for a hedging instrument that would help them manage the risks on their portfolio better especially in volatile market conditions. For instance, when the equity markets declined heavily last year, those institutional investors (foreign and domestic) who could anticipate it could only watch since there was no avenue available to them to hedge their risks.

Also, an efficient derivatives system is likely to be welcomed by speculators and arbitrageurs just as they accepted short and well-defined cash settlement market provided by the National Stock Exchange. I would like to make some further suggestions for revitalising the market.

First, the primary market. To rekindle the confidence of investors a safety net should be made. Holders of up to 250 shares should have the facility to sell back their shares to the company within six months.

Good government companies and Indian private sector companies should come with reasonably priced issues to the market so as to re-attract the primary investors.

The present system of the money being collected through banks could be replaced or supplemented by the Securities and Exchange Board of India authorised share collection centres.

A computerised list of application forms with cheque numbers should be forwarded by them within 48 hours of the closing of the list. Upon the finalisation of allotment only, cheques of successful applicants need to be sent to the bank; the rest should be returned without encashment. Thus the allotment time can be reduced drastically.

It is necessary to encourage and promote active participation of financial institutions in the capital market. The mutual funds will increasingly represent the small investors. Foreign brokers have also started to come in and their increasing number will signify the emergence of another major player in the market.

There needs to be greater coordination among the regulators. The SEBI feels the pulse of the market; all scandals are quickly reported and investigated. Therefore, it is the appropriate body to prescribe regulations for disclosure of information in the prospectus, as also to prescribe procedures for share issue and collection. These could, therefore, be put in the schedules for the Companies Act.

Measures to facilitate NRI investments must also be taken. Some Indian banks should be designated as the deposit banks for NRI application money. Companies collecting share applications abroad should thereafter transfer foreign currency to this bank preferably at three or four regional centres. Foreign applicants' accounts and refunds therefrom should be maintained in the same foreign currency thereby avoiding foreign exchange loss. This will also ensure speedy refunds.

Market making should be introduced at least for issues upto Rs 100 million. This would lead to better liquidity and would help in building up the investors' confidence. However, it is necessary to allow the market makers to have access to credit facility to allow them to achieve the desired results.

Coming to the secondary market, the stock market faces a problem of liquidity because majority of scrips listed are hardly traded. Out of more than 6,000 listed companies, about 3,000 companies have an issued capital of less than Rs 10 million. To ensure adequate liquidity in all scrips, the companies with capital of less than Rs 50 million should be made to seek listing on the Over the Counter Exchange of India.

Rolling settlements should get going soon. BSE had already done it at 1 + 5 for institutional trades. Trading hours have doubled from 2 1/2 hours. Uniform rolling settlements across stock exchanges are called for. NSE has over 70 per cent terminals accounting for 60 per cent trade outside Bombay. BSE is also witnessing upsurge. The question of many regional stock exchanges will have to be addressed. More important is professionalising of stock exchanges.

Terminal extensions can be opened in rural and semi-urban area at a subsidised rate of 50 per cent of cost to encourage the savings habit in the rural sector.

Market making should be made compulsory in all bought-out deals. Disclosures should be made of both the purchase price as well as the price band within which the issue is to be sold.

Stamp duty is a state subject which differs widely between states and results in cost differentials for issuers across states. Stamp duty should be reduced and made uniform across the states.

Policies framework should be made simple. It should also focus on bringing international practices on a holistic basis.

The SEBI has been issuing guidelines regularly. Market surveillance has to increase. The SEBI committee on short sales regulation should come up with a set of guidelines soon. Investors expect market manipulation to be tackled early.

Dematerialised segment should grow. The NSDL has crossed Rs 500 billion mark in demat.

I believe that like the economy we need demand stimulation in the market. Insurance companies are in an ideal position to do so. But they are reluctant participants. In fact, LIC has only four per cent of its assets in equity. Considering the fact that provident funds manager funds equivalent to 15 per cent of GDP, even at a 10-20 per cent level of exposure there can be massive infusion of funds.

The good news is that government has come out with divestment policy. Privatisation spells government's intention of dilution to below 50 per cent. Fair pricing PSU divestment is the issue. Golden means have to be formed. It is necessary to attract retail investors.

Provident funds have Rs 600 billion. They should join and translate the finance minister's policy into practice. The USA and China have used this effectively.

Regarding the Millennium Fund of the UTI, I think the report of task force could trigger action from all concerned. If the seminar and subsequent decision making leads to expeditious action, the resurgence of capital market could take place early. The FICCI's efforts will go amply rewarded. If RIBs could succeed in global market, I see no reason why resurgence of capital market cannot take place.

I would like to conclude by saying that systems have to be put in place which guarantee transparency. The quest for a fundamentally strong and liquid capital market lies in good governance, a system which assures immediate redressal of complaints and bookings of faults. Finally the capital market has to cut down its operational costs so that raising equity becomes a more viable option.

The writer is chairman of the Unit Trust of India. He spoke at a seminar on the resurgence of capital markets, organised by the Federation of Indian Chambers of Commerce and Industry recently in Bombay.

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