EQUITY MARKETS Stock Markets: Are they Barometers of Our Economy? R Vaidyanathan The myths that Indian regulators have regarding the Indian corporate sector and stock markets are dispelled in this article. After every stock market crisis, the analysts and the experts raise a hue and cry about the faulty regulations and policies by the regulatory authorities and in turn forget the core issues that need an immediate addressal. Even the Finance Ministry is caught amid these myths. There is a widely held assumption that Indian corporate sector plays a dominant role in the Indian economy and stock markets are the true barometers of the corporate sector. The other myths include that stock markets are channels of savings in the economy and the small investors are the worst affected by the stock market debacles. The author also discusses much more critical issues of interest to the small investors but ignored by regulators and the financial sector.T here are lots of discussion and system are not even reported leave alone usual breast beating about the discussed. That is the main issue of this small investors after any stock distorted obsession about the markets,market crisis. Any body who is somebody and it is based on several factuallybecomes overnight expert and ad nauseam incorrect assumptions about the role of thewails about the "harm done to the markets.economy" and "loss of feel good factor" and Stock Markets: Whom do they"confidence index" and what not? Give me represent?a break! These remarks of "two-second sound Let us look at some of the assumptionsbyte (TV) experts" are replicated in the pink regarding our stock markets Proposition # 1. Indian corporate in our economy (nearly 36 percent)papers and all the so-called intelligensia are sector is critical and has a dominant followed by Agriculture (27 percent)focusing on the relatively minor aspects of and Government (24 percent).our financial system. For most of them whatapply to NYSE or CBOT in relation to US role in the Indian economy The Major Characteristics of Corporate . Incidentally in activities like tradeeconomy automatically applies to our (wholesale and retail), transport (other India is:economy in relation to our stock markets.Has it not been established that we have . Corporate Sector’s share in national than Railways), construction, and Hotels and restaurant type activities, income is around 12 percent. Contrast withglobalized and hence our stock markets the share of non-corporate sector is the situation in USA where it is more thanrepresent our as well as the global more than 70 percent.economy? It would be simply amusing or alaughable matter but for the fact that the 60 percent. . Their share in domestic saving is less . The services sector, consisting of all these activities and not the than 10 percent. Contrast it to the developedfinance ministry mandarins are also caught manufacturing sector is currently countries where it is more than 50 percent.in this web of confusion. Many "experts" of them simply do not . Actually it is the non corporate sector the main driv er of growth of GD? . Between 1990 and 1998 thehave a clue to our economy or the financial consisting of partnership proprietorship average annual growth rate ofsystem. In the process more important firms (Bhagidari sector) which has theissues of our financial largest share@ ICFAI PRESS. All rights reserved.
EQUITY MARKETS RNBC Regulations The RBI regulates the activities of NBFCs through five sets of directions viz., i. NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 1998 ii. NBFC Prudential Norms (Reserve Bank) Directions, 1998 iii. NBFC Auditors Report (Reserve Bank) Directions, 1998 iv. RNBC (Reserve Bank) Directions, 1987 v. Miscellaneous Non-Banking Companies (Reserve Bank) Directions, 1977 Mandatory compliance by RNBCs with prudential norms for primary eligibility to accept deposits i. The provisions of prudential norms were extended to the residuary non-banking companies under the provisions of Non- Banking Financial Companies byRBl Directions, 1998. Every RNBC has to comply with prudential norms as pre-requisite for accepting of deposits in the interests of depositors protection. Accordingly, the RNBCs, which do not comply with the prudential norms, are directed to stop accepting deposits forthwith. Interest rates payable on RNBC deposits i. Residuary Non-Banking Companies (RNBCs) are the only finance companies, which pay a minimum rate of interest on their deposits, whereas other NBFCs can pay any rate of interest subject to the maximum ceiling on the interest rate prescribed by RBI. These companies are obliged to keep at least 80 percent of the aggregate deposit liabilities in the securities specified by the RBI on which the return is correlated to the yield on sovereign papers. In the wake of certain fundamental changes In the money market, like the bank rate has been reduced to 7 percent, the overall yield on their investments has declined. ii. RNBCs should pay interest rates on their deposits which shall not be less than: a. At the rate of 6 percent per annum on the amount deposited in lump sum or at monthly or longer intervals; and b. At the rate of 4 percent per annum on the amount deposited under daily deposit schemes. iii. Other provisions in this regard remain unchanged. Credit/Investment concentration norms for RNBCs In terms of the provisions of RNBC directions, the RNBCs are required to make investments of the deposit funds in the securities institutions have issued by certain specified institutions to provide security for their depositors. Considering that only select few been specified for the purpose, some of the RNBCs have represented to us that they find it difficult sometimes to adhere to the Investment Concentration Norms prescribed by us. In view of the above, the investment concentration norms shall not be applicable to RNBCs in respect of investments required to be made by them in approved securities, bonds, debentures and other securities issued by a government company or a public financial institution or a public sector bank, in terms of the provisions of RNBC directions. Source: ICFAI Research Center services sector was 7.9 percent while in manufacturing or trade or transport, you begin to think that it is the case the growth rate of industrial sector was construction or hotels. Hence the for all countries. Why take the pain of proposition that the corporate sector is looking at our numbers? How many 4.9 percent. an important or critical factor in our of these "experts" even know that The largest component of our savings economy is not borne out of facts. But huge manufacturing entities (in the (more than 80 percent) comes from it is repeated ad nausem since such form of partnerships) belong to Household sector, which include (due is the case in UK and US and if you household sector in the classification to our peculiar statistical system) all have done your degree, even in a third of savings. In the western economy, partnership / proprietorship firms even rated University from there, then household sector would be essentially if they are48 January 2002. Portfolio Organizer
EQU ITY MARKETS consuming or wage earning other words, the participants Large portions of our sensible households and it is assumed that would not have seen these scrips investors are in Postal savings and it is also true in our context since and a true "scripless trading" is in Provident funds and life funds. Thank God we have "globalized." place. The entire transaction is for for small mercies. So the proposition # 1 is neither gains or losses at the margin and Proposition # 4: Small investors true hence it is a Las Vegas facility are affected by the stock market debacles. nor valid and let the entire corporate provided originally to Mumbai There are thousands of Abhimanyus bosses go and jump in a lake (outside speculators and now the show is in our share bazarwho entered the Chakra India) and the national income open to Tindivanam or Tinsukia Vyuha in the early 90s and who are not become lesser by some 12 percent. patrons thanks to the V-Sat able to get out of it. Incidentally our national income is revolution. Why cry if some flinch If additional Abhimanyus have joined underestimated by at least 30 percent or cheats, since it happens in Las then they should curse their lack of "Epic and to that extent there is no loss at all Vegas also? (but the bouncers knowledge" by going to wrong, schools! If in the total picture. are Proposition # 2: Stock markets the barometer for the . take care in that place). Stock markets are neither the barometer nor the odometers for they were doing margin trading then they cannot be classified as "small investors" unless "experts" go by the height of the performance (past and future) of our corporates. The correlation investors in relation to the Big B. . the corporate sector. There are more than five lakh companies in India of which some could be seen some times between the two, since both contain large number of crooks and swindlers More than 90 percent of trade is at the margin for squaring off purposes as we saw earlier and those who dabble in it eight thousand or so are listed in linked with each other and the cannot be termed as small investors. The our exchanges for their shares and shenanigans could coincide. losers are sharks (actually they do not . bonds. Though nearly 9,000 scrips are listed in our exchanges; more than Proposition # 3: Stock Markets help in channeling savings in our economy. even lose since the nationalized Banks will be as usual the real losers remember the National Housing Bank and Harshad half were not quoted or traded last This is most Mehta) unless one argue that Bastar tribals year. Another 25 amusing assumptions below poverty line are active in the BSE! percent were Though market players of the lot. In the best To participate in this market, one quoted only a and exchanges blow of times, primary should be willing to lose his shirt and couple of times market did generate smile and come out. In other wor~, you during the last their about India should "wear an attitude" as they say. The some savings of the year. The shares having largest number public for the only person I know who wears an attitude of only five to 10 entrepreneurship of and no shirts is Salman Khan. All the of scrips listed [like companies Oswals, Bhansalis. shouting about small investors only reveal commanded morehaving the largest cattle Orkay Mehras, that large section of our media believes than 40 percent of population in the Deepaks, etc. The list that our entire financial system is located the trade is too long and those between "Dal<fl street" and "Arabian Sea" world], only around a . turnover. Contrast this with hundred scrips are the New York who are interested may go through our business journals were called in good old days as the devil and the deep sea. The small investors are not the losers active Stock Exchange, of the last ten years (particularly the cover in the sense in which we ought where no single stories) to see how these "whiz kids" and to understand the word "small investors". scrip normally "visionaries" are going to build a modem They are affected elsewhere (in the NBFC enjoys more than one percent of industrialized India! route) but about which nobody seem to. the turnover. The saving data suggests that in the Though mar kef players and best of times (not for the investors), the exchanges blow their bugle about proportion of "shares and debentures" as worry. Actually the problem with our stock markets is that some "outsiders" have also India having the largest number of percentage of financial savings of entered the market in the 90s and wanted scrips listed [like having the Households was 17 percent in the early to trade. Since it is only "insider trading" largest cattle population in the 90s and now in 2001 it is less than 2 which takes place there, the presence of world], only around a hundred percent. Of course there may be a some of. scrips are active. More than 90 percent of trading even in these hundred or so scrips is not for committee to search the "Primary Market" very soon, since it is "missing in inaction". delivering these shares. It is for squaring off purposes. InPortfolio Organizer. January 2002 49
EQUITY MARKETS "these ignoramus outsiders is creating RBI like any Central Banker is very talked about since Eastern India scams areconfusion. Just kick out the few coy (shall We say even bashful) and does passé and also it is not perhaps consideredouts iders then the market would not name these entities even though there glamorous to talk of vague illegiblerepresent the interest of only insiders are only five and having such huge categories like RNBCs (decipher it if youand function like a neat closed casino. deposits (comparable to many banks). can!). Incidentally these categories also Hence we may say, that the stock The depositors are lakhs in numbers from have some Bollywood stars thrown in formarkets represent the actions and the interiors of Up, Bihar and Bengal. the palate if that is what will makeconcerns of a few direct descendants Their net owned funds are minus Rs.666 discussion interesting!.of. Sakuni the great "Gambler of the crore. (Note that it is minus sign before Issue # 2: Banning UIBs (in financegolden era" and periodically Krishna, the number). They are supposed to invest sector) from accepting depositsthe Finance Ministry, is invoked by 80 percent of their funds in Government The non-corporate entities called Un-the Drupathi namely commercial securities earning some meager 8 to 10 incorporated entities [UIBs] in the financebanks since they are mortgaged as percent. sector play a very large role in the creditusual, without their knowledge. But 10 and beyold! They are not only delivery mechanism of our country. They This brings us to the important flourishing but some even runs Airlines. provide more than 70 percent of the creditpoint, pertaining to the critical current The deposits are pouring in requirements in sectors like tradeissues of our and you have an (Wholesale and retail), transport, privatefinancial system excellent set up with construction, hotels and restaurants andbeing totally Actually the problem with Managing worker in even for non-corporate manufacturing.ignored by the pink our stock markets is that the top in these outfits The Government agencies use the termand otherwisecolored papers and some “outsiders” have also whose aim is to serve "unorganized" for all non corporate form the country. The of activities which we will not use since itthe two-minute entered the market in the investigative is value loaded and these are betterbyters. (Actually 90’s and wanted to trade. journalists are silent. organized in terms of profitability, NPAs,they bark as much The RBI etc. than our corporate giants. Be that as itas they byte - these Since it is only “insider elsewhere states may.TV anchors!) trading” which takes place blandly that "The In the 90s there used to be a There are other there, the presence of some track record of restriction for any individual to acceptreal issues affecting compliance by these public deposits from 25 depositors or inthe entire financial of these ignoramus [residuary] the case of a firm or association ofsystem and small outsiders is creating companies has been individuals, not exceeding from 250investors and let us significantly lower depositors in the aggregate. Severalfocus on the confusion vis-à-vis other unincorporated bodies were advertisingforgotten but burning problems. NBFCs groups. Monitoring and aggressively through various media (TV Issue # 1: The bubble in East inspection of these companies, from time and newspapers) soliciting deposits fromwaiting to go bust in the NBFC to time, revealed continuance of many public by offering high rate of interest assector. unsatisfactory features including non- well as incentives. They floated several The recent report of RBI (Trend compliance with the core provisions of firms to overcome the 250 restrictions.and Progress of Banking 2000) the directions, diversion of the depositors This gave rise to significant accretion tosuggest that there were in all nearly money to associate concerns and or their deposits and many of them utilized it1550 Non-Banking Finance investment in illiquid assets, violations of for financing real estate, films, etc. HenceCompanies (NBFCs) in 1999. This is investment requirement pattern, etc. there arose the issues connected withafter all the shakeouts and new These features were impinging upon the liquidity as well as asset liabilityregulatory framework with interests of the depositors". mismatch. Many of the depositors wereregistration, rating, capital adequacy This I would call as "Satyajitrayisque" left high and dry and good number ofnorms, etc. These companies had - namely the understatement of the these firms went down under.public deposits of nearly Rs.21,000 decade. Anyhow I am sure our "experts" The Government went for a knee-jerkcrore. do not have such bad habits like reading reaction and promulgated an ordinance Interestingly five of these RBI tomes. banning of taking deposits by all Un- companies, classified as Residuary Hence a huge bubble is going to get incorporated bodies. Can you imagine Non Banking Companies (RNBCs), pricked sometime in the next few years crores of partnership firms all located in Eastern Zone (Lucknow and millions of small depositors in the and Kolkata) had public deposits of real sense of the term are going to be more than Rs.1O,500 crore (more than hurt. This is not investigated, not 50 percent). 50 January 2002. Portfolio Organizer
EQUITY MARKETSand moneylenders across the country be checked by the local cop or by the appetite to read and react to such issues.prevented from taking deposits to lend for Deputy Governor, I presume so. Are we What about the regional political Sultans.trade, commerce, etc.? But they were not a well regulated and rule oriented They are also silent. It is amazing.allowed to lend. That is, liability side of economy? What the Government could havethe balance sheet was abolished and assets There are four issues in this. One is done, is to ban 1V and newspaperside was encouraged. related to the ability of non-finance advertisements by these bodies in terms Can we think of any more absurdity businesses to accept deposits and to that of soliciting deposits. That actuallythan this? This was to prevent the cheating extent the finance bodies can circumvent created the loss for really small investors.of small investors. If there is cold then cut the said prescription. Another thing, which should be done, isthe nose said the modem mandarins. Of The other issue is pertaining to the to re-engineer the commercial banks tocourse these UIBs can lend from their own availability of adequate funds from lend to these UIBs which in turn can lendsources. That mean~ millions of cops can financial institutions for these to micro activities. They are more marketmake money in harassing that the small unincorporated bodies to carry on their savvy and they will have least NPAs.lender is taking deposit and asking him to activities. Commercial banker is not geared to lendprove he is not. The third issue is the squeeze in the to trade or Dhabas or construction or Silence from all experts. Pink papers transport of goods. For these you need UIB money market, where the rates arewere quiet. I think many did not market information on a continuous basis normally 2% to 3 percent per month forunderstand that the mandi interest rates and not reporting statements once a well run businesses. We are not talkingwere going over the roof (not the Mandi quarter. Post VRS, there is scope to about film or real estate or other highHouse in Delhi, which is the only place restructure the entire banking industry to speculative activities. We are talkingknown to these experts!) and lakhs of take these nonbank entities as channel about financing trade, Dhabas andsmall businesses did go bust. partners. transport and construction. These UIB Then the Government passed an This will decide how the interest interest rates are the main determinants ofamendment to RBI Act, modifying the rates in the wholesale Mandis of Hapur or the interest rates in our economy. Allordinance, prohibiting the category of Hindupur or Belagaum are going to be other rates like Bank Rates and PLR areunincorporated bodies carrying on decided which will decide our Rice and useful for arm chair discussion.financial business, to accept deposits from Imli and Turdhal prices. For many of thethe public. That is, if a person is running a Even the bank-lending rate for the Fast Moving Consumer Goods (FMCG)saloon or tailor shop or a Bhagidari sector is much more than the we find that the gap between thebutcher shop or stated rate due to middlemen and company balance sheet figure and theoperating two trucks or leakages. In that sense corporate sector street price figures to be more than 25running a Dhaba, then is highly subsidized percent and one factor in this is the opensuch a person is at liberty group in our market interest paid by the trade Commercial banker is notto borrow or accept economy. channels. In the developed market thisdeposits. But not, if you geared to lend to trade or The fourth gap is not more than 1012 percent. In theare in the business of issue is regarding case of cash crops and vegetables the gap Dhabas, or construction orlending. Can anything the regulations by between producer prices and consumermore "Thuglakian", you transport of goods. For these the State prices can be as high as 70 to 80 percent.can imagine than this? If I Governments and Here again the financing cost botham a money lender I you need market whether such an act holding arid transporting, plays a majorshould change my board information on a continuous by the Central role: I have been reading all sorts ofto a barber shop and then I Government is finance papers and magazines. There hascan borrow, otherwise a basis and not reporting not even a detailed report on this, leave valid regarding thelocal cop or RBI Deputy statements once a quarter UIBs. I am aloneGovernor will inspect my surprised that the any major discussion. No editorials or op-edrecords and hual me up. usual shouting breast-beatings. Of course the small financier can carry brigade of all Issue # 3: Red carpet foron his business either from his own funds varieties, particularly marxists are silent MNCs in money lending.or from funds borrowed from relatives or about this transgression on the State The recent recommendation by a highfrom the funds availed from financial sphere. May be because this pertains to level capital market committee of the RBI toinstitutions. This also will raw private capitalism at the operating allow 100 percent foreign level and any attempt to throttle the economy is good for the revolution or they simply has lost the Portfolio Organizer. January 2002 51
EQUITY MARKETSdirect investment in this sector has itself is absurd. What does an MNC from the rating agencies, which also havebrought the spotlight on the MNCs and bring to this money lending table when foreign equity participation.NBFCs. Indians have been doing this (perhaps In the current Budget (2001) it has Armed with a super fine rating based only this) for more than two thousandbeen suggested that" Provided that not on their Indian balance sheet (which in years.the foreign investors bring in a any way are not published) but on the Abolish and ban the local financier,minimum of US $50 mn, strength of their bring in the global players and so allForeign Direct parent - they go to the issues solved!Investment (FDI) in domestic market and The recent What is the impact on smallNon-Banking raise cheap funds. In businesses, impact on micro credit, etc.? recommendation by a high other words, they doFinancial Companies No discussion on this. level capital market not bring substantial(NBFCs) would not amount of dollar All " experts" are silent. It is not thehave to be committee of the RBI to money into the silence of the lambs. It is that of the well-accompanied with a allow 100 percent foreign country but at the fed bandicoots who have fattened out ofdivestment of 25 percent of same time able to corporate gift hampers and governmenttheir holding in the domestic direct investment in this generate domestic junkets.market". sector has brought the May be, it is wrong to focus on the resources relatively Incidentally they are real issues. May be, the inconsequential spotlight on the MNCs and easier compared tooperating in the market and inane only be our dominant issue of others.without any funds being NBFCs discussion. May be it is sort of dream or Actually some ofbrought from abroad. They auto-suggestive world where 1V screens the domestic government financialget decide what are the issues and sets the institutions are lending them at less thanwhat is known as a "comfort letter" or "get prime rates. This is a scandal in any other "National Mood". Who are we to suggestwell letter" from their parent bodies system but not in our blighted country. it is wrong? Have remote and have morelocated in places like New York, Chicago, Even assuming they are going to bring amusement since it is no more aor London, etc., which our GOI mandarins funds at 6 to 7 percent from their parent question of "Medium is the message"always like to visit. countries and after taking into account situation. It is simply that there are no This essentially imply that at least on forex risk also, they will make big killing more messages just the vacuous, hollowpaper it means that the overseas parent at our local markets with 30 percent medium. Enjoy it and of course "Dont gowill make good the shortfall should the upward rates. I think the idea away".capital of the Indian subsidiary erode forany reason. This get well letter fetches asound rating The author is professor of finance at lIM, Banga/ore. Keyword Non Banking Finance Company: Non Banking Finance Company (NBFC) is a loan company or an investment company or a hire purchase finance company or an equipment leasing company or a mutual benefit financial company. NBFC also can accept deposits ffom general public. Questions for discussion 1. Discuss the forgotten explosive issues that need to be addressed first, that are affecting the financial system as referred by the author. 2. Do you agree with the author that the time bombs ticking in the Indian financial sector would cause a much severe damage than the stock market crises? What proposals would you make to avoid them? Reference # 6-02-01.05