For two decades, the Indian stock market has had an upward momentum. That some of this was through NDA I, and ironically as the Kargil War raged, is interesting as a phenomenon. The market, we are told, marches to its own drum and anticipates the future. At the same time, even as key indices doubled and trebled, it built a higher base continuously, never falling back to original levels during periodic consolidations and corrections. And of course, it moved now in response to not just domestic issues, but global trends, as protectionist walls were lowered. The combination of openness and regulatory caution in India has kept the worst excesses from happening, even in the difficult days of 2008.

This maturing of the bourses began, it is seen, within seven years after liberalisation, in 1991. Probably as soon as some people, mainly Gujarati and Marwari market men, began to believe it was a permanent change for the better, after the long years of socialist constriction.

The fuel for the rise of the stock market though, which mirrored the real economy after a fashion till very lately, was almost exclusively the ingress of Foreign Institutional Investor (FII) funds. This showed up as billions of dollars, never seen before. Though in overall size, even now, it does not exceed $30 billion odd per annum.

The FII domination was palpable for years, and they controlled the rise and fall of the indices based on what they chose to do. Domestic retail and institutional money mirrored the FII plays, or sat watching on the sidelines. Our companies mostly, with the exception of Dhirubhai Ambani’s Reliance, did not dare to raise big finance from the stock markets at first and truth be told, there is much unexploited potential even now. The FII money, climbing over the years from a billion or two at first, is not a large sum as a proportion of international investment in the emerging markets. China gets over a $100 billion every year. The Indian portion represents a tiny percentage still. But nevertheless, it has been enough to transform. It took our bourses, over the years, from a turnover of just $250 million or less in the 1980s, through its stimulation, to around $2 trillion today. As it grew, there was intelligent speculation that a proportion of this money was Indian, round tripping, from clandestine Black to Hawala to White on the return journey, via the anonymous participatory notes (PN) route. This was a loophole that the Government of the day was loath to close for more reasons than one. PNs were hosted by the FIIs, but they did not have to disclose the identity of the beneficiaries. Another portion of the flow in was from global investment firms, taking advantage of no tax treaties with countries like Mauritius. These have recently been plugged in the main. But back in the day, investment entities registered there enjoyed nil taxation in India on their stock market profits. The domestic investors too had a lot of tax incentives and exemptions that exist to this day, but not for short terms of a year or under.

All the while, the relatively substantial domestic “household savings”, higher than any other country except China, stayed away from the bourses. Just 5% of this resource strayed from bank fixed deposits into equity, and sometimes the debt instruments, directly, via stock brokers, but more often than not, through private and government bank floated mutual funds. These made an entry into the country in 1993, and then grew exponentially over the years since. That is, with the exception of the government owned Unit Trust of India (UTI), which had a solitary mutual fund operating since 1964, joined by some more offerings in the 1980s, paying steady dividends for years. But eventually they, soon after the millennium, had to be wound up. Government owned funds were too often forced to invest in public sector units (PSUs), and other government debt, not always on commercial considerations, or to its own benefit.

But in fiscal 2016 all this changed organically. After a gestation period of nearly 23 years, the share of direct equity investment, much of it via personal trading accounts online, via the traditional brokers and through mutual funds doubled, from a largely inelastic 5.29% of household savings to 11.04%. This trend is likely to accelerate, due to better returns and much better tax treatment, compared to fixed deposits in banks. And because the dam of suspicion may have been breached at last. Domestic interest rates are trending downwards, with inflation and long term contracts in imported oil prices largely under control. This means fixed deposits in banks, taxable at the marginal rate complete with tax deducted at source (TDS), cannot do very much to satisfy going forward. Also, with real estate prices, the other big traditional favourite, stagnating with oversupply, there is less fresh speculative investment going into it.

The fuel for the rise of the stock market though was almost exclusively the ingress of Foreign Institutional Investor (FII) funds. 

Meanwhile, reflecting these tectonic shifts, overall asset management by the Indian mutual fund (MF) industry surged 30% to Rs 21.45 lakh crore in September 2017, up from 16.51 lakh crore just a year earlier. The MFs have reached into the tiered cities in a big way, for the first time as well. Investment from beyond the top 15 cities rose to Rs. 3.79 lakh crore in September 2017, up from Rs 2.74 lakh crore a year earlier, representing a rise of 38.5%. Individuals investing, as opposed to corporates parking their liquidity, rose a quantum 50%. This is represented by 6.68 lakh crore, up from 4.45 lakh crore a year ago.

The net effect of this surge in domestic, largely retail money, going into the bourses is that the markets have tended higher, ahead of results and fundamentals. Any corrections have been shallow and recent levels have seen all time highs.

Also, and importantly, the FIIs have been matched and bettered, and they cannot rule the roost and manipulate pricing anymore, unless they bring in much bigger monies than so far. But, at the same time, with even a strong, stable rupee to boot, they cannot stay away either.

The government, on its part, is earning international kudos for its structural reforms, such as the new bankruptcy law, and the introduction of an online linked Goods and Service Tax (GST), even though the execution of the latter has been clumsy.

The depth of the Indian financial market is insufficient to absorb quantum leaps in foreign investment without more structural reforms, growth, and modernisation across the board—in equity, debt, futures, options, derivatives and so on. Nevertheless, a continued surge from this point onwards is more than likely. The fact that India does not yet have a fully convertible currency when other much smaller countries do, is a glaring negative too. But, as is long held true of the real economy, the domestic demand for financial instruments too can be huge once the public sheds its inhibitions. India may indeed be waking up to the charms of the financial markets on a more widespread basis for the very first time.

With the cash economy being subsumed into the official one post demonetisation to a large extent, the joys of tax evasion are not what they used to be. Putting the money to productive use to earn higher yields instead of being forced to consume it as before, may benefit the erstwhile cash hoarder as much as the national economy. It calls for a shift in mindset, of course, but judging from the sharp increase in digital transactions, the change of heart may be taking place automatically.

All in all, it is probably true to say that the Indian mutual fund industry could begin to emulate the US giants as drivers of growth and excellence, with domestic houses plunging in to compete more effectively with subsidiaries of international giants. Investment bankers, will not just engineer mergers and acquisitions on an accelerated basis, but will increasingly tap the financial markets. They are expected to dwarf the banking universe for opportunities for their client start ups.

How long now before the paradigm shift from reticence to risk appetite like the Hong Kong Chinese? And when the bolder ones amongst the investment bankers look at launching some aggressive Indian hedge funds of their own?

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