`Capital markets a private club'

Interview with Prithvi Haldea, managing director, Prime Database.

IT is rare to find a market insider who has a cautionary tale to tell during the height of a boom. Prithvi Haldea, managing director of Prime Database, which tracks the initial public offers (IPO) market, is one such voice. He has been warning that the boom has no basis in fundamentals and that a collapse was always round the corner. He serves on several committees, including those of the Securities and Exchange Board of India, the Union Finance Ministry, the stock exchanges and industry organisations such as the Confederation of Indian Industry. Excerpts from an interview with him on May 31, the day the Bombay Stock Exchange Sensex crashed by more than 600 points:

You must have just heard the news from the markets. What happened?

There are various explanations in circulation. My explanation is that FIIs have taken a call that it is time to book profits. Our markets have substantially been driven by FIIs in the last four-five years. We are all now part of the FII watchers' club, trying to track what FIIs are doing. There is a huge over-dependence on FIIs. As long as they were buying, the boom story seemed to be in place. But the moment they started selling - and there is no law that says they cannot sell - the markets crashed. After all, they are basically here to make money. They have no national interest or even long-term interest. I see nothing wrong in a few FIIs feeling that it is time to sell.

But the problem is that our markets are very shallow. There are also no other big countervailing forces, such as institutional investors, against FIIs. Every sale by an FII thus leads to panic. Investors feel that FIIs have inside information, which is leading them to sell. Suddenly, overnight, a nation of buyers turns into a nation of sellers.

FIIs would obviously not say that they are selling to book profits. That would still be perceived to be a dirty thing to do. That is why we hear all kinds of reasons being given by FIIs - over-valuation of stocks, interest rate hikes in the U.S., a crash of commodity prices, and what have you. I think it all started when some FIIs felt that the market was over-heated. Prices of some stocks had increased by more than 100 per cent in the last year. A sane investor would not be satisfied with notional profits; he would know that the profits are made only when it is in his bank account. Every day, in the last 15 days [of May], FIIs have been net sellers.

Why are the markets so volatile?

The current volatility is because there is some support from the domestic financial institutions that are buying. There has been some resistance from mutual funds. Between January and March several mutual funds had mobilised funds from the market through New Fund Offers (NFO). Reliance Mutual Fund, for instance, collected Rs.6,000 crores in a single deal. So mutual funds, sitting on cash, are investing now.

Unfortunately, we do not have enough data to draw any substantial conclusions. As of today, I do not know which FIIs are selling. Neither do we have a geographical break-up of FIIs which are selling. Are they U.S.-based funds or are they from Mauritius? Are they pension funds or are they hedge funds? What kind of scrips are they selling? All this is not available in the public domain. The net figures on FII investment does not give us a clear picture of what FIIs are doing.

How does the dominance of FIIs amplify the volatility in the markets?

We are a very shallow market, in terms of both depth of investors and variety of investors. Less than 1 per cent of our people are investors. There are only about 50 lakh investors. We have no pension funds or long-term players. Mutual funds are of very recent origin and most of their funds have been raised only in the last six months. Provident Funds are not allowed to invest, banks are not big players and retail investors are anyway substantially out of the market. There is thus no countervailing force to FIIs. Earlier, the government could use Unit Trust of India and Life Insurance Corporation of India as countervailing forces in the market. Now there is no counter to FIIs.

The market also does not have breadth. There may be talk of 9,000 listed companies but we know that trade is concentrated in shares of only 200 of these companies. Moreover, the floating stock is limited because promoters and institutions hold a large part of the shares. Volatility is high because the number of investors and the volume of floating stock are very limited. In such a situation even a small trade can amplify price changes in the market.

Do you think there is excessive speculation?

Of course, speculation is excessive. Even the technology used in the markets has contributed to this. Technology can also destroy. For instance, the use of screen-based trading has converted traders to day-traders. Data from the National Stock Exchange show that 70-80 per cent of the trades are day-trades. These traders are only taking a call on narrow spreads within a day. Books and theories tell us that equities are all about long-term investments. Instead, equities have been converted into a day-trading market. This makes markets highly speculative and volatile.

Why is the system allowed to be so volatile?

(Laughs.) The big guys control the markets. Indian capital markets have become a private club. About 500-1,000 people - some FIIs, top brokers, some large investors and some operators run the market now.

Is this a market in which retail investors can participate?

No way. If they make money it will be purely out of luck. They have been edged out of the market. Scams keep happening and they have no protection. Data from the RBI [Reserve Bank of India] show that in 2004-05 only 1.4 per cent of household savings went to the capital market, compared with about 23 per cent 10 years ago. If we do not learn anything from this experience only God can save us.