The Daily Reckoning

Disinvestment: The more things change, the more they remain the same

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When finance minister Arun Jaitley presented the budget of the Narendra Modi government in February 2015, he set an aggressive disinvestment target of Rs 69,500 crore. Disinvestment refers to the government selling the shares it holds in public sector companies.

In late October, this aggressive disinvestment target was given a quiet burial.

A series of statements have been made in order to justify the slashing of the disinvestment target. “The target of Rs 30,000 crore seems more reasonable for current fiscal given that there is no big stock to sell,” a source told The Economic Times.

The minister of state for finance Jayant Sinha blamed it on the falling and low commodity prices. As he recently said: “One of the reasons why the divestment process is challenging right now is because many of the companies we are considering for divestment are in the commodity industries…Whether it is Coal India or OMCs (Oil Marketing Companies) and so on. They are impacted by global commodity prices.”

Sinha’s boss Jaitley more or less came up with the same reason when he said: “I don’t think it makes sense divesting at a time when [commodity] prices are low.”

How much sense does this argument make? Did commodity prices start to fall from March 1, 2015, a day after the budget was presented? On May 26, 2014, when Narendra Modi was sworn-in as the prime minister of India, the price of the Indian basket of crude was $108.05 per barrel. By February 27, 2015, a day before Jaitley presented the budget, the price of the Indian basket of crude oil had fallen by 44.6% to $59.85 per barrel. Hence, the price of oil had already been falling for a while at the time the budget was presented. The price of the Indian basket of crude oil is currently at $44.72 per barrel.

In fact, oil was not the only commodity falling. As an editorial in The Financial Express points out: “Similarly, in the case of copper, prices were $8,061/tonne in February 2013, $7,149 in February 2014 and $5,729 in February 2015—prices are down to $5,142.5 now. In the case of zinc, prices fell from $2,129/tonne in February 2013 to $ 2,034.5 in February 2014 and rose a bit to $2,098 in February 2015—prices are down to $1,687 now.”

So commodity prices were falling even in February when the government presented the budget. Why offer the reason now? Sinha offered another explanation as well: “Obviously, we have to ensure that we get best possible valuation for these valuable enterprises,” he said.

What does he mean here? On February 27, 2015, the BSE Sensex had closed at 29,220.12 points. Since then it has fallen by around 9.1% and closed yesterday (November 2, 2015) at 26,559.15 points. This is not such a big fall in the context of the stock market.

In fact, Jaitley had clearly pointed out in June earlier this year that a fall in the stock market would not lead to the government going slow on the disinvestment programme. As Jaitley had said: “I don’t read too much on daily movements as far as markets are concerned. By and large with the health of economy recovering, I see much greater stability as far as markets are concerned. And therefore, the disinvestment programme of the government will continue as it has been planned.”

So, if Jaitley was not reading too much into daily movements of the stock market in June, why is Sinha (and by that definition Jaitley as well) reading too much into the daily movements of the stock market, now?

Also, when an aggressive disinvestment target of Rs 69,500 crore was set, wasn’t the chance that the stock market will ‘fluctuate’ taken into account?

And why has all the optimism that was being projected on the disinvestment front by the government ‘suddenly’ evaporated now?

The stock market had touched a level of 26,500 points (as it is now) even in June earlier this year. So what has changed between then and now?

The broader point here is that the logic of commodity prices falling offered by the government to go slow on disinvestment now, was valid even at the time of presenting the budget. As The Financial Express edit quoted earlier points out: “If the government still went ahead and set an aggressive target for FY16[ 2015-2016], this implied it planned to be selling shares regularly, irrespective of the price—clearly that was an incorrect perception.”

Up until now the government has managed to disinvest shares worth only Rs 12,700 crore. Of this Rs 8,077 crore has come from the Life Insurance Corporation of India. So, there hasn’t been much disinvestment in the strictest sense of the term, nearly seven months into the financial year. What this tells us is that the government was not serious about disinvestment in the first place.

Given this, it is not surprising that the government has now decided to slash the disinvestment target. In fact, this has been a regular feature with almost all governments since disinvestment of public sector shares came to the fore in the early 1990s.

As AK Bhattacharya writes in a recent column in the Business Standard: “Since disinvestments of government equity in PSUs began in 1991-92, only on two occasions has a government met its target set at the start of the year. In the last year of the Narasimha Rao-led Congress government in 1994-95, total disinvestments of Rs 4,843 crore exceeded the target of Rs 4,000 crore set for that year and in the first year of the Atal Bihari Vajpayee-led government in 1998-99, total disinvestment proceeds were estimated at Rs 5,371 crore, compared with the target of Rs 5,000 crore.”
Of the total disinvestment target of Rs 69,500 crore, the government had budgeted Rs 28,500 crore to come in from the strategic sale of equity, which was basically a euphemism for privatisation. Nearly seven months into the financial year the government has given only given some indication of privatising IDBI Bank.

In this reluctance to privatise and continue holding on to companies, Narendra Modi is only following the Congress governments before him. In fact, TN Ninan makes an excellent summary of the way things stand as of now in his book The Hare and the Tortoise—The Challenge and Promise of India’s Future: “It is a matter of regret that Narendra Modi, who got elected on the promise of ‘minimum government, maximum governance’, has shown no taste for radical change or minimizing government…The government system continues to run loss-making airlines and hotels, three-wheeler units and Mahanagar Telephone Nigam, whose sales revenue is less than 40% of expenditure.”

Meanwhile, as I sit writing this column, its one am in the morning and one of the TV channels is replaying Modi’s election speech in Bihar.

As the old saying goes, the more things change, the more they remain the same.

(The column originally appeared on The Daily Reckoning on November 3, 2015)

A 200 year old economic theory tells us what is wrong with the developed world today

Jean-baptiste_SayVivek Kaul

I like to quote a lot of John Maynard Keynes in what I write. The reason for that is fairly simple—Keynes is the Mirza Ghalib of economics. He has written something appropriate for almost every occasion.
Nevertheless, I’d like to admit that even though I have tried to read his magnum opus The General Theory of Employment, Interest and Money a few times, over the years, I have never been able to go beyond the first few chapters.
The economist whose books I find very lucid is the Canadian-American economist John Kenneth Galbraith. Galbraith unlike other economists of his era was a prolific writer and was one of the most widely read economists in the United States and other parts of the world between the 1950s and 1970s. He was even the US Ambassador to India in the early 1960s.
His most popular book perhaps was The Great Crash 1929, a fantastic book on the Great Depression, which he wrote in the mid 1950s. His other famous work was The Affluent Society published in 1958.
But the book I am going to talk about today is A History of Economics—the past as the present. In this book Galbraith looks at the history of economics and writes it in a way that even non-economists like me can understand it.
One of the laws that Galbraith talks about is the Say’s Law. This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced,” wrote Galbraith explaining Say’s Law.
The Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”
And this law explains to us all that is wrong with the developed world today. As Bill Bonner writes in his latest book Hormegeddon—How Too Much of a Good Thing Leads to Disaster “French businessman and economist, Jean-Baptiste Say, discovered that “products are paid for with products,” not merely with money. He meant that you needed to produce things to buy things; you could not just produce money…has anyone ever mentioned this to the Federal Reserve?”
The central banks in the developed world have printed close to $7-8 trillion in the aftermath of the financial crisis which broke out in mid September 2008, with the investment bank Lehman Brothers going bust. The Federal Reserve of the United States has printed around $3.6 trillion dollars in the aftermath of the crisis to get the American economy up and running again.
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right, people need to be encouraged to borrow and spend. As John Maynard Keynes put it: “Consumption—to repeat the obvious—is the sole end and object of economic activity.” (There I have quoted him again!)
To get borrowing and consumption going again central banks have printed a lot of money to ensure that the financial system remains flush with money and interest rates continue to remain low. At low interest rates the chances of people borrowing and spending would be more. And this would lead to economic growth was the belief.
Now only if economic theory worked so well in practice. Also, it was “excessive” borrowing and spending that led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales explain this very well in a new afterword to Saving Capitalism from the Capitalists, “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
It is worth pointing out here that the share of United States in the global production of goods has fallen over the last few decades. Thomas Piketty makes this point in his magnum opus Capital in the Twenty First Century. Between 1900 and 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases they used to in the past.
Piketty further points out that the minimum wage in the United States, when measured in terms of purchasing power, reached its maximum level in 1969 and has been falling since then. At that point of time, the wage stood at $1.60 an hour or $10.10 an hour in 2013 dollars, taking into account the inflation between 1968 and 2013. At the beginning of 2013, the minimum wage was at $7.25 an hour, more than 28 percent lower than that in 1969.
This slow wage growth has led to Western governments following an easy money policy by making it easy for people to borrow. As Michael Lewis writes in The Big Short—A True Story: “How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”
In case of the United States, trade with China had an impact as well. As the historian Niall Ferguson writes in The Ascent of Money: A Financial History of the World: “Chinese imports kept down US inflation. Chinese savings kept down US interest rates. Chinese labor costs kept down US wage costs. As a result, it was remarkably cheap to borrow money.”
Ironically, what worked earlier is not working now. What has happened instead is that financial institutions have borrowed money at low interest rates and invested it in financial markets all over the world, in search of a higher return. Despite the central banks printing a lot of money, Japan recently entered a recession, with two successive quarters of economic contraction.
Europe is staring at a deflationary scenario. And the economic recovery in the United States continues to remain fragile.
Further, over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a downward pressure on costs and prices in the years to come and hence, wages in developed countries aren’t going to go up in a hurry.
Moral of the story: Western nations need to go back to making things, if they want a sustainable economic recovery. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”

The article originally appeared on equitymaster.com as a part of The Daily Reckoning, on Nov 28, 2014

The sucker flag is up, as the retail investor is back into the stock market

Vivek Kaul

It’s morally wrong to allow a sucker to keep his money – W C Fields

The Indian retail investor is a sucker. He invests when the markets are high and he gets out when the markets are low. Don’t believe me? Look at the table that follows.
This table shows the net inflows(total inflows minus total outflows) into equity mutual funds in India during the course of a financial year. As can be seen in 2007-2008 equity mutual funds saw a net inflow of Rs 40,782 crore. This was the time when the stock market was on fire. In early January 2008, the Sensex almost touched 21,000 points. It had started the financial year at around 12,500 points.

earInflows/Outflows in/from
equity mutual funds (in Rs Crore)
2007-200840,782
2008-20091,056
2009-2010595
2010-2011-13,405
2011-2012264
2012-2013-12,931
2013-2014-7,627
2014-2015 (from April 1,2014 to October 31 2014)39,217

Source :Association of Mutual Funds in India


And when the party was on the retail investor couldn’t have been far behind. He poured money into equity mutual funds. In January 2008, equity mutual funds saw a net inflow of Rs 12,717 crore. The stock market started to fall from mid January onwards. In fact, the Sensex fell from 21,000 points to 17,500 points in a matter of a few days.
So, the good things came to an end pretty soon. Over the next few years, the faith of the retail investor in the stock market came down dramatically and inflows into equity mutual funds almost dried down. In 2010-2011, the outflows from equity mutual funds reached Rs 13,405 crore. The trend continued in 2012-2013 and 2013-2014 as well.
What these data points clearly show us is that the retail investor poured money into the stock market at high levels and got out only once the market started to fall. The opposite of the buy low, sell high, strategy that the stock market experts keep talking about. But what else do you expect from a sucker.
Nevertheless, things seem to have started to change again. The retail investor seems to be back into the stock market. This financial year (between April and October 2014) has seen a net inflow of Rs 39,217 crore into equity mutual funds. And if things go on as they currently are, the year might see the highest inflow into equity mutual funds ever.
This is not surprising given that the Sensex has rallied by close to 25% between April and October 2014 to reach almost 28,000 points. And this has got the suckers interested in the stock market all over again.
In fact, the Indian retail investor isn’t the only sucker going around. Maggie Mahar in her book Bull!—A History of the Boom and Bust, 1982–2004, makes a similar point about American investors during the dotcom bubble.
Between 1982 and 1996, the Dow Jones Industrial Average gave positive returns in 12 out of the 14 years. In eight of the 12 years that the Dow had given positive returns, the absolute return had been 20 percent or more. This led to more investors entering the stock market.
The number of investors in the stock market increased, as many middle class investors made their first jump into the stock market. Wealthier Americans already owned stocks. Nearly three-fourths of those having financial assets of $500,000 or more had made their first investment in stocks sometime before 1990. Some 33 percent of the households with financial assets of $25,000 to $100,000 bought their first stock or invested in a mutual fund that in turn invested in stocks between 1990 and 1995. But 40 percent of those owning financial assets in the range of $25,000 to $99,000, and 68 percent of those with financial assets of less than $25,000 made their first purchase after January 1996.
So, the American retail investor started taking interest in technology stocks only after January 1996, and by that time the dotcom bubble was well and truly on. A similar sort of dynamic was visible in the real estate bubble that followed, when a large number of individuals started taking loans to buy homes that they wanted to flip, only by 2005-2006, when the bubble was at its peak.
Economic theory tells us that more often than not, higher prices dampen demand and lower prices increase demand. But when the stock market witnesses a bull run, investors do not behave like normal consumers.
As Mahar puts it in Bull! “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vacations. Conversely, lower prices usually whet our interest: color TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”
This is something that every investor should try and remember.
What these examples show is that the retail investor tends to enter a market only once its done well for a while. In the process he or she ends up making losses or limited gains.
Let’s compare this to a situation of an investor who had invested regularly in the stock market over the years, through a systematic investment plan.
Let’s consider the Goldman Sachs Nifty BeES fund for this exercise. This particular fund is essentially an exchange traded index fund and invests in stock that constitute the Nifty index. A regular monthly investment in this fund from September 2007 till November 2014, would have yielded a return of 14.10% per year. During the same period the Nifty has given a return of around 9.15% per year, barely matching the rate of inflation.
What is the point of investing in the stock market over the long term, if you can’t even beat the rate of inflation?
Now let’s say you had started investing in January 2008, when the stock market was at a then all time high level and continued to invest in the Nifty BeES till date. The returns on the systematic investment plan would be 14.84%. During the same period the Nifty gave a return of 4.5% per year. Some savings accounts would have given more return than that.
Moral of the story: Successful stock market investing can be simple and boring at the same time.
To conclude, retail investors entering the stock market in droves has been a clear sign of the market nearing its high levels, in the past. Is that the case this time around as well? This remains a difficult question to answer given that foreign investors are the ones really driving the Indian stock market.
As long as Western central banks maintain low interest rates, these investors can borrow money at low interest rates and invest them in financial markets all over the world, including India. Given this, the retail investor entering the market right now may not turn out to be suckers at the end of the day.
But the same cannot be said about the retail investors still waiting in the wings.
Stay tuned.

Disclosure: The basic idea for this column came after reading this piece in the Business Standard

The column originally appeared on www.equitymaster.com on Nov 13, 2014

Of foreign investors, China and the Hotel California song

china

In response to the last column a reader wrote in on Twitter saying “shudder to think what would happen [to the stock market] if FIIs[foreign institutional investors] packed their bags and left.” Since the start of the financial crisis in September 2008 and up to October 2014, the FIIs have made net purchases (gross purchase minus gross sales of stocks) close to Rs 2.76 lakh crore in the Indian stock market. During the same period, the domestic institutional investors(DIIs) made net sales of Rs 95,219 crore.
The FIIs have continued to bring in money even during the course of this year. Between January and November 10, 2014, they had made net purchases of stocks worth Rs 65,751.25 crore. During the same period, the DIIs had made net sales of stocks worth Rs 30,136.32 crore.
Over and above this, the FIIs own around 26% of the BSE 100 stocks. Deepak Parekh in a recent speech estimated that after excluding promoter shareholding and the retail segment, which do not have too much liquidity, FIIs dominate close to 70% of the stock market.
What all these numbers clearly tell us is that the foreign investors run the Indian stock market. But that we had already established in the last column. In this column we will try and address the question as to what will happen if foreign investors packed their bags and left? The simple answer is that the stock market will fall and will fall big time. The foreign investors control 70% of the stock market and if they sell out, chances are there won’t be enough buyers in the market.
Nevertheless, the foreign investors also know this, so will they ever try getting out of the Indian stock market, lock, stock and barrel? This is where things get a little tricky.
Let’s try and get deeper into this through a slightly similar situation in a different financial market. Over the years, the United States(US) government has spent much more than it has earned and has financed the difference through borrowing. As on November 7, 2014, the total borrowing of the United States government stood at $ 17.94 trillion dollars. The US government borrows this money by selling financial securities known as treasury bonds.
A little over $6 trillion of treasury bonds are held by foreign countries. Within this, China holds bonds worth $1.27 trillion and Japan holds bonds worth $1.23 trillion. Even though the difference in the total amount of treasury bonds held by China and Japan is not much, China is clearly the more important country in this equation.
Why is that the case? James Rickards explains this in great detail in Currency Wars—The Making of the Next Financial Crisis. The buying of treasury bonds by the Japanese is not as centralized as is the case with China, where the People’s Bank of China, the Chinese central bank, does the bulk of the buying. In the Japanese case the buying is spread among the Bank of Japan, which is the Japanese central bank, and other institutions like the big banks and pension funds.
The United States realizes the importance of China in the entire equation. Right till June 2011, China bought American treasury bonds through primary dealers, which were essentially big banks dealing directly with the Federal Reserve of the United States. But since then things have changed. The treasury department of the US (or what we call finance ministry in India) has given the People’s Bank of China, a direct computer link to its bond auction system.
Also, there is a great fear of what will happen if the Chinese ever decide to get out of US treasury bonds, lock, stock and barrel. It will lead to a contagion where many investors will try getting out of the treasury bonds at the same time, leading to a fall in their price.
A fall in price would mean that the returns on these bonds will go up, as the US government will continue paying the same interest on these bonds as it had in the past. Higher returns on the treasury bonds will mean that the interest rates on bank deposits and loans will also have to go up.
This can lead to a global financial crisis of the kind we saw breaking out in September 2008. Nevertheless, the question is will China wake up one fine day and start selling out of US government bonds? For a country like China, which holds treasury bonds worth $1.27 trillion, it does not make sense to wake up one day and start selling these bonds. This as explained earlier will lead to a fall in bond prices, which will hurt China as the value of its investment will go down. China has invested the foreign exchange that it earns through exports, in treasury bonds.
As on September 30, 2014, the Chinese foreign-exchange reserves stood at close to $3.89 trillion. Hence, nearly one third of Chinese foreign-exchange reserves are invested in US treasury bonds. Given this, it is highly unlikely that China will jeopardise the value of these foreign-exchange reserves by suddenly selling out of treasury bonds.
What China has done instead is that since November last year its investment in US treasury bonds has been limited to around $1.27 trillion. Also, some threats work best when they are not executed.
Hence, when it comes to the Chinese and their investment in treasury bonds, the situation is best expressed by the Hotel California song, sung by The Eagles: “You can check out any time you like, but you can never leave.”
Now let’s get back to the FIIs and their investment in the Indian stock market. Isn’t their situation similar to the Chinese investment in US treasury bonds? If they ever try to exit the Indian stock market lock, stock and barrel, it is worth remembering that they control nearly 70% of the market. When foreign investors decide to sell there won’t be enough buyers in the market. Hence, stock prices will fall big time, leading to foreign investors having to face further losses on the massive investments that they have made over the years.
Given this, are the Chinese in the US and foreign investors in India in a similar situation? Does the Hotel California song apply to foreign investors in India as well? Prima facie that seems to be the case. But there is one essential difference that we are ignoring here.
Nearly one third of Chinese foreign-exchange reserves are invested in US treasury bonds. Hence, China has a significant stake in the US treasury bond market. The same cannot be said about foreign investors in India’s stock market, at least when we consider them as a whole.
As Deepak Parekh said in a recent speech “India ranks among the top 10 global equity markets in terms of market cap. However, India accounts for just 2.4% of the global market capitalization of US $64 trillion.” Given this, in the global scheme of things for foreign investors, India does not really matter much.
Hence, if a sufficient number of them feel that they need to exit the Indian stock market, they will do that, even if it means that they have to face losses in the process. As mentioned earlier, in the global scheme of things, these losses won’t matter. Also, a lot of money brought into India by the FIIs has been due to the “easy money” policy run by the Federal Reserve of the United States and other Western central banks.
These central banks have printed money to maintain interest rates at low levels. The foreign investors have borrowed money at low interest rates and invested in the Indian stock market. Once these interest rates start to go up, it may no longer make sense for them to stay invested in India. Of course, it is very difficult to predict when will that happen.
Nevertheless, it is worth remembering what Steven Pinker writes in his new book The Sense of Style—The Thinking Person’s Guide to Writing in the 21st Century: “It’s hard to know the truth, that the world doesn’t just reveal itself to us, that we understand the world through our theories and constructs, which are not pictures but abstract propositions.”
And whatever I have written in today’s column is my abstract proposition. Hence, the question still remains: Will foreign investors ever sell out of the Indian stock market, lock, stock and barrel? 

Sensex at 28,000: Will the real Indian stock market investor please stand up?

bubbleVivek Kaul

I have cooked my own food for over 12 years now. Over the years, as boredom from cooking on a daily basis has set in, the quality of what I cook has deteriorated. These days the food I cook is just about edible.
Given this, I like to watch some mindless television while eating. This ensures that I don’t pay attention to what I am eating and as a result, don’t end up cribbing to myself. What works best in this scenario, especially during lunch time, are business news channels.
If you are the kind who still watches them, you would know that a major part of the day on these channels is spent in trying to figure out which way the stock market is headed. The anchors of these channels talk to so called “experts” who give their “gyan” on why they feel the market moved the way it did, and which way they think it’s headed in the future.
More often than not these experts are optimistic and keep telling us that the market is only going to go up from here. Nevertheless, as you and I know that is not how things always turn out. It is especially interesting on days the markets rise, to see these experts thump their chests and tell the viewers “I told you so!”
The reasons for their optimism vary from day to day. It can be low inflation on one day and the hyperactive Modi government on another. On days they run out reasons they like to tell us the “India growth story is still intact”. Come rain or sunshine, these experts always have their reasons ready. And that makes it great fun to watch.
(I have to confess here that I have this recurring dream where I have been invited to a studio of a business channel and am asked “Mr Kaul, which way do you think the stock market is headed?” And I look write into the eyes of the anchor and tell her “Mam, it’s headed only one way and that’s up”.
“Why do you say so?” she asks, with her eyebrows fluttering. And I reply: “The whole country of the system is juxtaposition by the haemoglobin in the atmosphere because you are a sophisticated rhetorician intoxicated by the exuberance of your own verbosity.”)
Jokes apart, these experts especially the Indian ones, never really tell us the real reason behind the Indian stock market going up.
Between April 2007 and October 2014, the foreign institutional investors(FIIs) made a net purchase(gross purchase minus gross sales of stocks) of Rs 2.06 lakh crore in the Indian stock market. During the same period the domestic institutional investors(DIIs) made net sales of Rs 22,715 crore.
Things get more interesting once we look at the numbers between September 2008 (the month the current financial crisis started) and October 2014. During this period, FIIs have made a net purchase of Rs 2.76 lakh crore. In the same period, the DIIs made net sales of Rs 95,219 crore. These data points tell us very clearly who is really driving up the Indian stock market. In the aftermath of the financial crisis breaking out in September 2008, the developed nations of the world led by the United States and United Kingdom carried out quantitative easing or printed money and pumped it into their respective financial systems, to keep interest rates low.
This was done in the hope that at low interest rates people would borrow and spend more, and all the spending would help revive economic growth. What happened instead was that large financial institutions managed to borrow money at low interest rates and invested it in financial markets all over the world. This has driven up stock markets all over the world, including the BSE Sensex.
The inflow of foreign money has been particularly strong this year. As Abhishek Saraf and Abhay Laijawala of Deutsche Bank Market Research point out in a recent report “On a year to date basis too, India has witnessed the highest FII inflows into equities at ~US$14billion.”
This has helped the Sensex rally by more than 33% since the beginning of this year. But the interesting thing is that DIIs have continued to stay away. Since the beginning of this year they have made net sales of Rs 27,241.5 crore.
Nevertheless, October 2014 has been an exception to this, with the DIIs making a net purchase of Rs 4,103 crore. This is for the first time since August 2013, when the net purchase of the DIIs was higher than that of the FIIs. In fact, FIIs made net sales of Rs 1683 crore during the course of the month.
The question to ask here is why have the DIIs not invested anywhere as much as the FIIs have in the years since the financial crisis broke out. The answer lies in the fact that DIIs (primarily insurance companies and mutual funds) ultimately invest money they collect from the retail investors.
The retail investors had bailed out of the stock market lock, stock and barrel, in the aftermath of the financial crisis. They haven’t returned since. A major reason for the same was the fact that insurance companies sold expensive unit linked insurance plans (or Ulips) to retail investors.
Many agents promised investors that their money once invested in the stock market would double in three years. That clearly did not happen, and individuals who had bought Ulips essentially went around footing the bill for the high commissions that insurance companies paid their agents. And this ended up giving the stock market a bad name.
Also, many retail investors started entering the stock market only in late 2007, when the market was already at a very high level and ended up making losses. As Deepak Parekh said in a speech last week in Mumbai “Retail investors tend to enter stock markets on the highs and lose confidence on the lows.”
Further, DIIs represent only the indirect participation of the retail investor in the stock market. What about the direct participation? This is very minuscule. As Parekh pointed out “On the retail side, the picture is grimmer. Direct participation of retail investors in Indian capital markets is 1.4% of the population compared to China at 9.4%, UK at 16% and US at 18%.” Or as maverick investor Shankar Sharma once told me during the course of an interview “The Sensex is just a two square mile phenomenon — Fort to Nariman Point. That is about all that is interested in the Sensex.”
Parekh in his speech estimated that after excluding promoter shareholding and the retail segment, which do not have too much liquidity, FIIs dominate close to 70% of the market. What this clearly tells is that it is the FIIs have used the “easy money” provided by the central banks of Western countries to drive the Indian stock market, and, in turn, have benefited the most from it as well. This has also helped the BSE Sensex cross the level of 28,000 points more than a few times in the recent past.
Given this, the next time you see an Indian expert trying to give you reasons on why the stock market is rallying, try and tell this to yourself: “he knows not what he is talking for he is on television.”
To conclude the question to ask here is whether it is time to allow big provident funds like the employee provident fund, the government provident fund and the coal mines provident fund to invest a part of their corpus in the stock market? This will be one way of ensuring that some regular Indian money also keeps coming into the stock market and foreign investors are not the only ones to benefit. And that is something worth thinking about.

The article originally appeared on www.equitymaster.com on Nov 11, 2014