An illusion of wealth

India's new-found wealth is but a pyramid of cards built by a bunch of flighty foreign investors.

C.P. CHANDRASEKHAR

INDIA is now home to a new breed of billionaires: those created by an almost inexplicable rise in the values of the stocks they hold. Epitomising these changes are Azim Premji, chairman of Wipro Ltd., and N.R. Narayana Murthy, the chief executive officer of Infosys Technologies. These entrepreneurs from the IT (information technology) sector, along with others from the entertainment and communications arenas, are creating new records in the stock markets that are not always warranted by what they have a chieved on the ground.

Consider the much-publicised Wipro story. On January 3, 2000, Wipro's share price ruled at Rs. 2,809. In a bull run that began around the middle of the month, the price climbed almost continuously to touch Rs. 8,929 by February 18. In a world where stock values are increasingly used to value individual wealth, this close to 220 per cent increase in the course of a month has placed Premji, who owns 75 per cent of Wipro stock, among the world's richest people.

Such stories abound, even if they are less dramatic than this example of a move from a position of relatively puny wealth by international standards into the ranks of the world's wealthiest. This easy, even if recent, movement at the apex of the wealth p yramid, has added one more cause for celebration for a globalising intelligentsia (rather loosely defined) which has seceded from the nation which harbours it. That segment had hitherto assessed the success of economic reform by the individual success of people of Indian origin in Silicon Valley and Massachusetts, besides of course their own salaries. Now they can add the emergence of paper billionaires to the list of India's achievements.

What is disconcerting is that increasingly market capitalisation, or the value of a company computed on the basis of the price at which individual shares of the company trade in the market, has replaced real asset values as the principal indicator of com pany size and worth. The top 50 or 500 are now determined by many analysts not on the basis of asset value but market valuation. This is part of a larger disease which assesses the size (and ostensibly, therefore, maturity) of India's stock market based on total market capitalisation.

The consequences are dramatic. In 1990, before the reform process began, total market capitalisation in the Bombay Stock Exchange (BSE) was less than Rs.100,000 crores - a level that the market capitalisation of Wipro alone crossed on February 2 this yea r. Aggregate market capitalisation in the BSE stands today at around Rs.1,100,000 crores, which reflects an average increase of 100 per cent a year during the 1990s. This is not only taken as suggesting a dramatic rise to maturity of the stock market, bu t as reflecting economic buoyancy, even though it conveys a completely different picture than that provided by GDP growth, which averaged around 6 per cent compound a year. This disjunction of the financial from the real sector almost mirrors the other d isjunction of a part of the Indian mind from the Indian reality behind the smokescreen of Hindutva.

A RESULT of this dissonance is a rather dubious interpretation of the growing distance between real and financial growth and wealth in the country. This is that India too is home to a new economy, consisting of areas such as information technology, the e ntertainment 'industry' and financial services, which mediate and explain the distance between the real and financial sectors. These areas, it is argued, are the ones which define India's comparative advantage in a globalising context and are the wealth creators of the new millennium. They are the ones where India is truly part of the world community and can stand on its own. They are the true new temples of modern India, and not steel, power and heavy industry which occupied the Nehruvian mindset. Not surprisingly, according to this view, even while markets are buoyant and wealth is being almost magically created, Steel Authority of India Limited has to be provided with a massive financial restructuring package, including a Rs.5,454-crore debt write-o ff, in order for it to remain in operation.

Forget for a moment that the capabilities and skills that provide the wherewithal for the emerging businesses are a direct product of the past, which now stands condemned. Consider the true nature of the financial expansion that is occurring through Indi a's stock markets. To start with, market values of individual shares are not a reflection of the true worth of the companies involved, but the state of demand for those shares relative to their supply. Demand, at the margin, is clearly being driven by fo reign institutional investors in search of diverse portfolios, who now number more than 500 in the country.

The tastes for shares of these investors are known to be volatile, shifting across national boundaries and continents for reasons that are not easy to identify. But India, it is clear, is the flavour of the times. During the first 18 trading sessions in February, the foreign institutional investors (FIIs) invested more than Rs.2,660 crores, which was more than half the annual average investment that occurred during the years since 1993, when FII investment in India's stock markets was first allowed. The inflow during these days was in fact higher than the inflow during the last six months of 1999. Clearly, there has been a sudden surge of interest in India.

THREE factors appear to explain this trend. First, a speculative boom in IT stocks in general and Internet stocks in particular in American markets. Second, the fact that among the emerging markets India is a country with a growing IT presence in U.S. ma rkets, strengthened by strategic alliances with leading U.S. firms. Finally, the fact that those Indian firms that have gone in for a Nasdaq listing in American markets have performed quite well, encouraging other Indian firms in the IT and entertainment sectors to contemplate a similar strategy.

These factors have virtually ensured that the speculative fever in IT and related stocks in the American markets has spilt over into the Indian market. For example, the bull run in Wipro shares came in the wake of two major strategic alliances the compan y had forged with Microsoft, the software giant, and Symbian, the combination of leading players targeting the emerging market for wireless devices that link to the Internet. It should be expected that a similar trend would obtain in other areas like the entertainment business where the integration of Indian operators with international players is significant.

While the demand for Indian equity in selected sectors is spurred by these factors, the supply of such shares is limited for two reasons: first, internationally acceptable players are still small in number, even if increasing over time; and, second, the number of shares from such enterprises that are available in the market are limited. As mentioned earlier, only 25 per cent of Wipro shares are with the "public" as opposed to the promoter, and most of those holding such shares are unlikely to be ready t o part with them in the course of a boom. The net result is that the demand-supply balance at the margin is heavily weighted in favour of sellers, resulting in astronomical price increases in short periods of time. This is true of other companies as well . Needless to say, if many promoters chose to exploit the situation by off-loading a significant chunk of their holding, the demand-supply balance for shares of individual companies could change substantially, resulting in a fall in prices that is as dra matic as the previous rise.

Despite this dependence of share prices on the limited supply resulting from a high holding by the promoter and his associates, the market capitalisation index applies the price at the margin to value the stock of the company. This results in a dramatic surge in the "market value" of the company along with the price. Not surprisingly, a few firms and sectors account for the recent surge in market capitalisation. By mid-February, Wipro alone accounted for 15 per cent of the market capitalisation in the B SE, and the combined market value of around 150 software companies accounts for 32 per cent. It must be remembered that at the beginning of the 1990s, these companies hardly featured in the BSE.

In short, India's new-found wealth is like a pyramid of cards built by a bunch of flighty investors. Small money by world standards is rushing into a few sectors, honing in on a few companies which have a small number of shares on trade. This pushes up p rices at the margin to create an illusion of wealth even as the economy trudges along the same old growth rate, because the commodity producing sectors, especially agriculture, languish. But for the boys at the top, things appear as if they could not hav e been better.

ALL this would have mattered little if the implications for the real economy were not adverse. To start with, the rush of dollars into the economy comes at a time when a recession-induced deceleration in non-oil imports and large remittances from Indians working abroad has kept the current account deficit at relatively low levels. This increases the supply of dollars in the market and would cause the exchange rate to appreciate, unless the Reserve Bank of India (RBI) purchases these dollars and adds the m to its already large reserve of foreign currency assets.

Since an appreciation in the exchange rate would affect India's poorly performing exports adversely, the RBI does increase its foreign asset holding, which would contribute to an increase in money supply. But because a monetarist mindset dominates the ce ntral bank and the government, they seek other ways of controlling the growth in money supply. Principal among these is a curb on central bank credit, especially to the government.

One consequence of this is that the government is forced to borrow from the market at higher interest rates, even while keeping expenditure under control. The net result is a fiscal crisis even when expenditure is being reined in. This is taken as a case for curtailing expenditure further, even when unutilised capacities in industry, declining capital formation in agriculture, large food stocks with the Food Corporation of India, substantial foreign reserves and low inflation, all cry out for larger inv estment by the government. The state is put in retreat precisely at a time when it should be expansionist, just because a few flighty foreign investors have chosen to make themselves and a few domestic entrepreneurs rich through games played on the stock market.

To top it all, these games of speculation are bound to give way to a crash in stock prices when it becomes clear that there is nothing at present or in the future which warrants a share to trade at 750 times the annualised per share earnings of a company , as it does in the case of Wipro. When the fall begins, much of the $11 billion of investment that poured into India's stock markets since the early 1990s may be withdrawn, setting off a run on reserves and a fall in the currency. The implications of th e financial crisis that can ensue need no elaboration in the wake of the South-East Asian experience. Crucially, such a crisis sends the real sector into a steep recession, making the real sector and those whose livelihoods depend on it, pay for the spec ulative inclinations of a financial world repeatedly driven by shortsighted, speculative euphoria.