Exuberance can be rational

Prominent among them are economic affairs officials from the government, the Securities and Exchange Board of India, the Reserve Bank of India, mutual funds who indirectly represent millions of small investors, and investment bankers who play a key role in pricing of shares when initial public offers are made. Mutual fund managers and investment bankers represent private interests, but are categories that have social significance because of the way their roles are tied with those of the retail investors, whose insufficient participation in the market is of frequent concern to government officials. Their significance will increase as the country switches increasingly to a system where retirement plans of common citizens will be tied to personal savings administered by professional fund managers.

Now, what exactly are the gentlemen and ladies in such institutions and funds doing as the Sensex tumbles away after touching lifetime highs of more than 12,000, all over just a few weeks? Prime Minister Manmohan Singh infamously said when he was finance minister during the 1992 stock market scam that it was not his job to lose sleep because the market goes up or down. That attracted flak, but not much, because it was an India still largely innocent to the ways of global capital. Things have changed significantly. The sudden shift of FIIs is a key factor in the current bedlam, and it is also clear that levels of foreign exchange reserves that determine the value of the rupee — and hence substantial behaviour in the economy — are also influenced by FIIs.

The government and regulators have a role to play somewhere to reassure retail investors. In a world where small investors puts hard earned savings into mutual funds, it is the job of the regulators to ensure that investment guidelines for mutual funds do not put them at a disadvantage with respect to FIIs and hedge funds. FIIs, with their monetary muscle, have much more elbow room to take out and put in funds and it appears there is an imbalance of power they enjoy in India vis-a-vis domestic mutual funds.

While this imbalance remains a fact of life, mutual funds are thriving on the sale of units rather than performance. They sell much more when the market is booming and it is an open secret that mutual funds in the past one or two years have been drumming up fresh investments from retail investors with stories that look alluring, only to face redemption pressures as they are doing this week when the market comes crashing. Mutual funds usually take refuge in the premise that stock market investments prove good in the long term, but that is no excuse for irrational behaviour in volatile market conditions. The funds are largely behaving like commission agents.

Commercial banks have used the stock market boom to cross-sell mutual funds, merrily joining the commission agent bandwagon, and sales pitches have been bandied as “investment advice” to unsuspecting retail investors. Surely, RBI and SEBI officials have something to discuss on this, perhaps with the finance ministry in attendance.

Finance Minister P. Chidambaram said after the first of the recent Sensex slides that he was told the market correction was technical in nature and the fundamentals of the economy were strong. His comment overlooked high oil prices and the worry they spell for the government or the fiscal deficit. He has not said much after subsequent dips in stock prices. It is quite clear that sneezes in the North Block mean colds on Dalal Street, and whether he likes it or not, the finance minister is an institution that somehow represents stabilising rationality in the stock market.

Now, for the investment bankers. These are the smart men and women who help companies raise capital from the public. Despite the statutory “red herring” prospectuses prescribed by Sebi and loaded with risk factors, issuing companies by and large sell shares much the same way as Hindustan Lever sells soaps — with hype, hopes and aggression.

On Monday, Deccan Aviation (which owns Air Deccan) and Unity Infraprojects, a construction company, closed about 30 per cent below their issue price on the day of their listing debut on the stock exchanges after their IPOs. In a rational world, this should cause aggressive buying the next day, if the prices were determined by responsible individuals. Both stocks slid 14-15 per cent more on Tuesday. Though it is true that IPO prices are usually arrived at by “book building” in which investors bid within a set price band, investment bankers, who are often only an arm’s length away from research analysts, have a key role in influencing prices. When they act in irrational exuberance, there can be significant social fallouts for the retail investor. In the 1980s, a hardfisted Controller of Capital Issues in the finance ministry determined IPO prices, and we cheered well when that office, a big symbol the licence-permit raj, met with its end. But then, with the bathwater of babu-pricing, did we throw out the baby of rationality? Regulators and government officials need to establish a market ecosystem that encourages rational behaviour, in the long term interests of an investor culture.

The writer is senior editor with The Financial Express madhavan.nexpressindia.com