Market mayhem

THE Indian stock market, which had been on a high ever since the Narendra Modi government assumed office last year, dropped like a stone on August 24. The Bombay Stock Exchange’s (BSE) Sensex registered its biggest single-day decline on Black Monday, dropping by 1,625 points, a decline of nearly 6 per cent. When markets closed for the day, the Sensex rested at 25,741.56, its lowest level in 12 months. It was as if an athlete who is habituated to performance-enhancing drugs was suddenly deprived of his quota for the day. The Sensex’s fall that day was its biggest single-day decline in seven years, and its third biggest single-day drop since it was constituted in 1986. To make matters worse, the rupee dived to its lowest level against the U.S. dollar (Rs.66.47) the same day, its lowest level in almost two years.

Market analysts saw August 24 as perhaps the worst day since the global crisis in 2008. Share prices of more than 500 companies, mostly from the mid-cap and small-cap space, hit the lowest permissible limit for the day. Investor “wealth”, a notional term describing the value of stock holdings, plummeted by Rs.7 lakh crore, of which nearly Rs.4 lakh crore was lost in a single hour of trading.

A large brokerage pointed out that as many as 526 stocks traded on the BSE dropped to their maximum permissible limit for a single day. The massive sell-off triggered by the withdrawal by foreign institutional investors (FII) resulted in 205 stocks touching their 52-week lows. These included stocks of all kinds from every possible sector. Among them were Aban Offshore, ABG Shipyard, Adani Power, GAIL, ICICI Bank, NTPC, ONGC, Tata Motors, Tata Steel, VST Industries and many more. While metals and metal-based companies, including steel majors such as Tata Steel, SAIL, and Hindalco were clearly hit by the fever that had spread from the currency and stock markets to the global commodities markets, banking stocks such as those of ICICI and HDFC, in which FIIs had a commanding presence, were hammered by their hasty exit. In the three sessions ending on August 24, FIIs sold off shares worth more than Rs.8,500 crore.

During the weekend preceding the crash on August 24, the government announced that it would sell 10 per cent of its stake in the premier public sector oil refiner Indian Oil Corporation Ltd on August 24. The sale of the stake, priced at a minimum floor price of Rs.387 per share, was to enable the government to mop up at least Rs.9,396 crore.

On the day the markets crashed, the government bravely continued with its offer of sale even as the share price dipped below the floor price, reaching below Rs.365 per share during the day even as the markets were rocked by the crash. No wonder retail investors stayed away from the Indian Oil sale: why would investors subscribe to the offer at the minimum offer price of Rs.387 per share when it was cheaper in the secondary market? But curiously enough, the stake sale went through “successfully”.

Even as the government swore in the name of the free market, it nudged the publicly owned insurer, the Life Insurance Corporation, to bail it out. The LIC responded brilliantly by mopping up more than 86 per cent of the Indian Oil Corporation shares on offer even as FIIs were pulling out at a feverish pace. It is arguable whether the LIC’s role as a white knight in the Indian Oil sale undermined its potential role as a countervailing force when the markets dived when FIIs rushed to the exits on August 24.

Vinod Nair of Geojit BNP Paribas Financial Services apparently believes this to have been the case. He argued that the LIC’s diversion of large volumes of liquidity to salvage the stake sale robbed it of the ability to play a countervailing role when the all-round crash happened on the same day.

On August 25, a day after the mayhem, the Sensex swung like a yo-yo, diving a further 400 points before closing 200 points higher than its closing level on the day of the crash. When markets closed on August 27, although the index had gained 489 points from Monday’s trough, it became clear that the markets still remained extremely volatile. Although analysts and equity fund managers attributed the collapse to global factors, primarily the “China effect”, they were quick to add that the crash was a wake-up call for the government to get economic reforms back on track.

Of course, there was a ready explanation for the carnage on offer. Happenings in China—the devaluation of the yuan and the subsequent crash in the stock markets there—were to blame for the rout, said the punters. The country’s financial leadership, including the Finance Minister and the heads of the stock exchanges, bravely maintained that the India story remained intact, that the “fundamentals” remained strong and that this was only a temporary blip. The financial authorities’ reaction was not surprising. The country’s “fundamentals” remained strong, asserted Union Finance Minister Arun Jaitley.

Reserve Bank of India Governor Raghuram Rajan said the central bank would “not hesitate” to use its “very sizeable foreign currency base” to combat the volatility of the national currency. The Chief Economic Adviser to the Finance Ministry, Arvind Subramanian, said India may need to respond to the Chinese devaluation in order to provide Indian exporters with a more competitive field of play.

Interestingly, the Finance Minister and the RBI Governor offered different perceptions of India’s role on the world stage. Two days after the crash, Raghuram Rajan commented that although the growth rate in India may be higher than China’s in the short term, the country was nowhere near being an “engine” for the global economy. However, Jaitley’s bravado was in sharp contrast a couple of days later, when he suggested that India had the “viable shoulders” to provide support to the sagging global economy. Jaitley may have been better advised to set his own house in order before seeking the world stage.

A closer look at the fundamentals that he regards as being sound shows that all is not well. Inflation may be under control, but this has been achieved by a deflation of large swathes of the Indian economy. Industrial output remains flat, exports have registered eight straight months of decline, and agricultural output is at the very best likely to remain stagnant. Despite all the talk since the last Union Budget about a pickup in government investment, not much has been achieved.

The logic that connects happenings in the market to economic realities has always been suspect. But this is heightened by the fact that the floating stock in most of the blue-chip companies—shares that are not held by institutional investors or the government and which are therefore not available for churning in the market on a daily basis—is cornered by FIIs. It is perhaps this stranglehold that explains why the market crashed so hard on August 24. As in all speculative ventures—whether betting on stocks or on horses—it is futile to search for an explanation. Any explanation for herd behaviour, which is what happened when all the FIIs headed to the exit at the same time, is only offered after the event in any case. It is like posting an explanation for an event after it is over; so one explanation is just as good as any other on offer.

Explaining the crash

When markets crash, as they did on August 24, two contending views come to the fore. One side, represented by an assortment of analysts, fund managers, corporate honchos —basically those hankering for yet more reforms—are on their feet, demanding more reforms. This is exactly what Jaitley tried to respond to, in the name of calming the nerves of investors.

Every conceivable item on the reform agenda has been thrown into the ring in the aftermath of the crash: the promise to ensure the passage of the Goods and Services Tax and legislation that would make land acquisition for industrial use easier and cheaper, the announcement of a reconsideration of the Minimum Alternate Tax (MAT) on corporates, and the promise to accelerate the pace of privatisation. For instance, Ranjit Dongre of Bellwether Capital attributes the sluggish behaviour of the market to the government “not delivering on several fronts”.

Significantly, he also observed that corporate earnings are unlikely to pick up with an increase in government spending. Although global factors were at work in the latest crash, the “internal situation is not just negative, it is quite bleak”, Dongre told Frontline . “The markets have to find a level before they do a dead cat bounce,” he remarked.

The diametrically opposite view to this cacophony comes from those who, even if not having a stake in the markets, have an eye on the larger economic reality. The irony is that while gung-ho reformers argue that all is well with the fundamentals and that everything would be fine if only investor “sentiment” is assuaged by yet more “reforms”, the other side picks holes in these very fundamentals.

It is tempting to provide some context to the crash, after the initial shock and awe has worn off. The story of the upward spiral of Sensex can be traced to early January 2014, when the media started projecting the Modi-led National Democratic Alliance as the frontrunner in the elections due in May 2014.

The Sensex moved from 20,787 on January 6, 2014, to 22,500 in early April 2014. And, by the time the election results came in in May 2014, the Sensex sprinted to 24,374—an increase of 17 per cent in a span of just four months. It is important to realise that no asset class, except perhaps those operated by the loan sharks in the country—rural as well as urban—could have offered anything like these returns.

But more was to follow. The Sensex climbed even higher, riding the huge wave of expectations that Modi had so assiduously built throughout his campaign. On January 29, 2015, it touched its all-time high of 29,682.71.

This implied that the index had increased by a whopping 43 per cent in a year. But as the promise of ache din faded in the face of grim reality, the Sensex slid to about 27,000 in April 2015, and dipped to 26,000 in June 2015.

In fact, there were several occasions on which it lost over 500 points in a single day in this period. In fact, such instances happened even in August, before it went into a free fall on August 24. Indeed, even at its level on the day of the recent crash, the Sensex was almost 25 per cent higher than its level in January 2014, when the Modi bandwagon moved into top gear. The fact that the spectacular upswing of the index has been way out of sync with key economic parameters is a telling testimony to what the markets mean to real economy.

It is not surprising that the country’s leadership sees the latest crash as an “opportunity” to unleash further reforms. In the face of the fundamentals staring the economy, that could only be construed as being an opportunistic move to appease whimsical investors at the cost of the wider economy and society.