Why have the markets tanked? Financial Express: 8th November 2008

The Indian stock market has fallen quite dramatically over the last three months and the analysts who conjured visions of the Sensex touching 25,000 earlier this year are now trying to explain the lows in the range of 7000-8000. A slower economic growth this year, could explain a part of the story, but the kernel of the meltdown lies elsewhere. Curiously, the Indian stock market has become a reflection of the actions of the FIIs, which is significant as it reflects the strengths and weakness of the market.
The strength is revealed in the fact that the Indian market has now become globalised in the true sense and is able to take into account the benefits of the same as the actions of the FIIs get reflected in our own market. However, the weakness that has to go along with such a package is that our markets become vulnerable to the changing strategies that they pursue which makes them shaky at times. Unfortunately, this isn’t always related to fundamentals.
FIIs have withdrawn a net amount of close to $16 bn in the first 10 months of 2008 which works out to approximately Rs 65,000 cr from the equity market. Their actions have had a decisive impact on the Sensex which has tended to fall sharply every time they have moved funds out in a big manner. This has happened in June, September and October when they withdrew as much as much as $ 7.8 bn from the market. In the first 5 months of the year, the Sensex ranged between 15,500 and 17,500 with a fall being witnessed sharply in March, when the FIIs had a neutral position. Subsequently, the FIIs have been on the selling spree that has accelerated the decline which got the ultimate shove in September when the CDS crisis erupted. The question that needs to be raised is why should this be significant?
The FIIs account for around 1/3rd of the total transactions (buy plus sell) that take place in the equity market. The number should not actually be driving the market as there is another 2/3rd which is being driven by the other elements. Mutual funds accounted for around 8% of the total transactions in the equity market in the first 10 months of calendar 2008, which implies that the balance actually comes from other institutional investors and the retail segment.
The FIIs as a group tend to act in the same manner as they are driven by virtually the same factors individually. They see a market to invest in when the P-E ratios are attractive. However, given that they have diversified interests in various markets as they are investing globally in equity, debt, derivatives and bonds, they take a macro view and balance out the net gains across markets. Hence, a financial crisis in the US on the derivative side implies losses for them which in turn would make them unwind their positions across the globe even in say the equity markets overseas, causing a sharp fall in the emerging markets.
Mutual funds have also had a role to play in this story even though their share is low. In fact, the fact that their share is low raises certain questions. In the first 10 months of the year, out of a total net investment of Rs 68,000 that was made by these funds, only Rs 10,500 crore went into equity while the rest was ploughed into debt. Quite clearly, the investors were wary of the equity segment as the revealed preference for this segment means that individual investing in debt funds (FMPs and money market funds became popular) did not expect the equity book to really last for longer.
The message hence is quite clear. Our markets are going to be driven by the FIIs as the rest of the market is going to take cues from their actions. Higher growth or lower inflation or a strong corporate performance will probably swing the market temporarily—maybe a few days. But over a 1-year horizon, the FIIs rather than the mutual funds would continue to show the way.