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A Broader Role Is Absent

The lack of meaningful domestic long-term equity investment has broken the capital markets’ basic cycle…

If you are above a certain age, then you would vividly remember particular dialog from Sholay. Gabbar Singh is boasting to his henchman about how scared people are of him. ‘…jab baccha rota hai,” says, “toh maa kehti hai ki beta so ja. So ja nahin toh Gabbar Singh aa jayega”. There’s a stock market equivalent of this line, whereby an investor warns another one not to buy anything on the markets right now because FIIs might start selling (you can imagine the actual line).

Over this last decade, the biggest change that has happened in conversations that investors have with each others and their brokers is the outsize role that the foreign institutional investor has taken on. All of us who analyse the markets have got a narrative about how the markets have gone up because of the tremendous growth in the economy and in Indian businesses. But that’s not the way the markets work. Stock prices don’t go up as an automatic reward for growth.

First, someone with the ability and the willingness to invest has to notice that growth, take a call that the growth will continue and then put down actual money. If enough investors do this in large enough volumes, then and only then will the markets follow. It’s important to note that temporal direction of the cause and effect here: investors have no interest—and rightly so—in past growth. They invest in expectation of future growth. The past is important only as a guide to the future.

In India, the role of leading the market, by the nose, as it were has been played by the FIIs for a long time now. Now, I‘m not one of those who think that FII investment in India this is automatically a bad thing—it’s not. By itself, it’s a great thing. However, what is a bad thing is that there is no meaningful domestic long-term equity investment. This effectively short-circuits the broader role that the equity markets should be playing.

The equity markets in a growing economy are a two-way contract. Businesses get access to capital and investors get chance to get far better returns than they would get through fixed-income investing. Unfortunately, this contract doesn’t function in India. Let’s look at the various ways in which investors’ long-term savings can reach the markets. The traditional first answer is direct retail participation in buying stocks, preferably in IPOs. Unfortunately, IPO investing in India is entirely about punting on the first day price now. Those who invest in IPOs believe (and they’re mostly correct) that IPOs will be priced and timed in such a way that there’s no way of making money except to find a greater fool on the first day. For the better part of two decades now, various tricks have been tried to entice the retail investor to invest in IPOs. These tricks no longer work, something that is probably evidence of good sense on the part of retail investors. Meanwhile, growing businesses that could genuinely have been part of a robust IPO markets go to foreign PE funds and the like for equity.

Another major channel for long-term equity investments are of course mutual funds. Funds have sort of succeeded but it’s the kind of success that, in the larger scale of things, is not meaningful.
India’s mutual funds manage equity investments that are currently worth Rs 2 lakh crore. This is the cumulative amount total grown over the years. From an investment point of view, fresh inflows are nothing. In the last 24 months, net equity fund inflows have been Rs 1,430 crore. This sounds like a lot of money, but when you put it in perspective, it’s a drop in the ocean.

The one bright spot on the horizon was supposed to be the New Pension System. As originally envisaged, the NPS would have led to a huge volume of very long-term, stable equity investments. These would have led to exceptional benefits for the participants as well as the equity markets. However, this vision all but dead. The latest is that a parliamentary standing committee has said that NPS members should get a guaranteed return that is at least as much as the EPFO’s returns. Effectively, this means that the NPS’s journey to becoming yet another government-guaranteed fixed-income scheme is well on its way.

It’s a depressing story. The basic cycle of the capital markets—whereby household savings get deployed in good businesses and the households get owner-like returns—is completely broken. On the one hand, business are starved of equity capital and on the other the capital markets are the abode of short-term punters trying to manoeuvre some profits out of the ebb and flow of short-term foreign money.