RBI concern over stock market volatility

The stock market began 1999-2000 on a subdued note on account of domestic uncertainties, but firmed up after September 1999. This was driven mainly by FII inflows and signs of industrial recovery; the formation of a new government at the Centre; upgrading of India’s international ratings from stable to positive by international credit rating agencies and favourable expectations from information technology stocks.

The BSE-Sensex crossed the 5,000 mark on October 8, 1999 and the 6,000 mark in the intra-day trading on February 11, 2000. FII investments increased by Rs 2,835 crore in February 2000.

The sharp increase in the inflows of foreign private capital into India in the nineties has increased the cross-border financial integration. Till 1992-93, foreign investment flows to India were insignificant. Following the opening up of the local capital markets to portfolio investments, India attracted large foreign investment flows during 1993-94 to 1997-98 averaging $5.1 billion per annum.

Most of these flows were in the form of portfolio investments during 1993-94 and 1994-95. From 1995-96, direct investment flows also picked up and exceeded $2 billion each year. Foreign investment flows dipped in 1998-99, mainly on account of weakening sentiment for emerging markets in the aftermath of the financial crises in east-Asia. In 1999-2000, foreign investment flows revived, with direct investment exceeding the $2 billion and portfolio investment $3.0 billion mark.

Net foreign direct investment (FDI) flows to India as a percentage of net FDI flows to all developing countries (as published in the Global Development Finance, World bank, 2000) exhibited a sharp increase from about 0.2 per cent in 1991 to more than two per cent by 1997. Since then, India’s share has declined. However, in terms of net inflows in all different forms (private and official), India seems to have attracted a fairly stable percentage of flows, except during 1994-96 when certain fluctuations occurred.

The RBI report adds that another way to measure degree of financial openess is to see the co-movement in the domestic stock markets and international stock markets.

As a result of large capital flows, especially portfolio investments since 1993-94, the sensitvity of local stocks to developments in international stocks has increased. The impact was particularly strong in 1999-2000 as movements in the technology stocks in the Nasdaq had a significant bearing on the Indian stock markets.

The RBI says that an analysis of the prices of the Indian GDRs/ADRs in the international stock markets and the stocks in the domestic markets also reveals that the two prices are highly correlated. The correlation coefficient between the BSE Sensex and the Skindia-GDR Index for the period April 1996 to August 2000 worked out to 0.64. It, however, may be noted that many Indian GDRs/ADRs listed on the international bourses during the period 1993-94 to 2000-01 (upto August) traded either at discount or at premium.