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Markets: Under scanner!

Sep 23, 2005

The chart-bursting rally over the past couple of weeks may have left market participants rejoicing and swearing on their 'bullishness' over the oft-repeated 'India story', but the governing bodies (Securities and Exchange Board of India (SEBI), CBDT and Ministry of Finance to name a few) seem to be losing sleep over it. Once bitten twice shy (after instances such as Black Monday), the Finance Ministry has roped in several investigating bodies to probe into market manipulations that are rampant in mid and small caps during bull runs.If the reader is still wondering about the gravity of the situation and the rationale behind the market's impulsive reaction to the same, let us bring certain facts to your notice.

One of the main premise on the basis of which the 'India story' is cited to be attractive is the fact that foreign investors have increasingly hiked their exposure to Indian equities over the past couple of years. However, if one were to probe into the quality of such foreign fund inflows, the results are not very comforting.

Direct investment - churning portfolios
A study of the direct foreign investment into Indian equities shows that, despite the upturn in capex cycle, the incremental inflows in the form of FDI (foreign direct investment) have remained stagnant over the past couple of years. On the other hand, it is the earnings in domestic markets that are being re-invested (i.e. portfolios are churned) and adding to the net fund flows. This is primarily because the rate of return in domestic markets continues to be relatively attractive as compared to that in the overseas markets and foreign investors do not seem to wish to take home their fortune as yet! Also, the increasing disparity in exchange rates (e.g. US dollar depreciation vis-a-vis the rupee), is further improving the rate of return. No wonder, the FDI to GDP ratio remains a meager 5% for India at the end of FY05 as against 30% for Thailand and 35% for China.

Portfolio investments - FIIs rule
While the above facts relate to individual investments, a study of the 'portfolio investments' also indicates that only a small quantum of the foreign money is parked with a long-term perspective and a major portion is repatriatable. This is because, despite the government's consistent efforts to encourage equity investment in Indian companies through the ADR/GDR route, such investments comprised a meager 7% of the total foreign portfolio investments in the country in FY05 (Source: RBI).

On the other hand, the fact that the quantum of Foreign Institutional Investors (FIIs) flows has shot up in the last two years raises some concern as such funds are notorious for being 'hot money'. The Fed's relentless effort to raise interest rates (despite hurricane devastations) and pressure of energy crisis on the Indian economy may well prove to be triggers for the 'pull back' of the FII money in the near future. Given the excessive proportion of such funds in Indian equities, an adverse impact of the pull back will be inevitable on the Indian indices.

The mantra for retail investors...
"A pin lies in wait for every bubble and when the two eventually meet, a new wave of investors learn some very old lessons", said the legendry investor Warren Buffet. It thus goes without saying that the retail investors need to prove themselves a wiser lot this time by staying away from the market mayhem and not speculate over the day-to-day movements.

Investing in fundamental stories with a long-term perspective has time and again proven to be the saving grace whenever the markets have tried to orphan the retail investor. These principles are advocated by us not just to douse your worries about being an insignificant player in the market but also to reassure you of our faith in some of the robust fundamental stories of India Inc.

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