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May 6, 1997


How paan shops will give way to trading terminals

India is a land of ironies. The world thinks India is a country of opportunities. But those who live in India do not seem to share the optimism.

Look at the broad p/e on the exchanges. We have, after the US, possibly the largest number of listed companies on the stock market. But the number of stocks that are actively traded are not more than 20.

The country's market capitalisation has broadened considerably over the last 10 years but there are a number of counters which trade fewer shares today than ever before.

If there is one major stumbling block that stands between India and the emergence of a world-class trading centre, it is the absence of liquidity. The Big Five (SBI, Reliance, TISCO, ACC and ITC) represent over 85 per cent of the volumes on the National Stock Exchange. The rest trade in dribs and drabs, grabbing attention one day and vanishing the next.

Perhaps the best example of liquidity improving market capitalisation is reflected in the global depository receipt quotes of some companies and their corresponding domestic prices.

Have any of you ever wondered why Arvind Mills which quotes around Rs 140 on the Indian stock exchanges, quotes for the rupee equivalent of around Rs 180 on the GDR market?

Or take a stock like Core Healthcare. It quotes around Rs 30 in India but upwards of Rs 50 on the global exchanges - a variation of around 70 per cent!

One can understand foreign players agreeing to pay the future premium of around 4 per cent on the dollar. But has anyone bothered to think why they would be willing to pay a premium ranging from 2 per cent to nearly 70 per cent in various cases?

The answer is liquidity, or rather the lack of it. When an FII invests in India, he is scared that his shares may be labelled as having bad delivery or that due to a thin market the shares may not sell at all.

The global market is different. Even the number of GDRs are lower compared with the potential free float in India. The trading is thicker. One can exit when one wants. The result is that traders are willing to pay a higher price for this facility of entry and exit.

Why then is the Indian market illiquid? Why are FIIs looking only at a select 30? Why are FIIs ignoring the rest even though the rest of the counters sell for a fraction of the p/e of the top 30?

Observers list a number of reasons. One. The sustained decline in the value of shares has taken the interest off investing, so the volume of trading has trickled down to nothing. Two. The markets are highly institutionalised. If the Unit Trust of India is a net buyer of Grasim, then the speculative interest that inevitably follows tends to make Grasim a high-volume counter. But when the UTI turns a net seller, interest tapers just as fast. Three. Traditionally promoters kept stocks of their companies on the boil by being near-active players. Effective insider trading laws, the prevailing absence of an opportunity to raise capital and a general shortage of liquidity has turned a number of these counters inactive.

The result is highly skewed. Increasing inflows of foreign invisible resources into the country come with a rider: That the money must go back to the owners in a blink - if required. You might say that no serious investor puts his money into India without at least a three-year horizon. Well, I used to think so too. But look at the number of instances that have made them turn increasingly short-term in their outlook.

We were sitting comfortably convinced that stocks would continue to climb until a Sunday evening in March. Suddenly, Sitaram Kesri withdrew support. And so is born the need to be immediate and urgent about investing in India. If investors want to come in, they all want to come in immediately after the elections. If they all want to move out, it is after Congress says thank you very much and pulls down the shutters. If they hold obscure - but perhaps worthy - stocks they will continue to keep holding the same until the next elections.

But if they are holding TELCO and TISCO, they could be out on the night of the jitters itself.

This is precisely what is happening. Traders play the ITC stock not out of a great sense of bullishness (if at all, investors ought to be worried about the anti-smoking drive and the company's internal problems) but because they believe that ITC represents a fair proxy for the market.

Most are aware that the tobacco stock at 30-plus p/e represents no bargain . Whether it deserves to get the MNC label is by itself debatable in the light of certain events over the last year. And yet, the ITC stock is one of the few stocks which everyone wants to know of at the end of a trading day to get a feel of how the market has behaved.

Apparently, liquidity is becoming an enduring virtue.

Value-seekers will scoff at the liquidity-led school of thinking. But it appears that the latter have a convincing argument in their favour. One. What is the utility of value when it is likely that the p/e may never rise ? Two, value seeks liquidity - not the other way around.

The second is an interesting argument. Do trading volumes rise in stocks where the price is low and the value huge? Or does investor interest tend to rise in stocks in which it is easy to enter and exit?

A definitive answer is beyond the scope of this column. Suffice it to say that the stock of the country's largest profit maker in the private sector has emerged as the traders' favourite over the last number of years. Not because corporate profits have registered a sustained increase. But because of the facility of easy entry and exit.

The history of the price movement of Reliance Industries is for all to see. In the 1992 boom the price moved up to Rs 300. And today the price is Rs 300. Who has made money? Not the investors, the bastion of Reliance's booming empire. The people who have gained are the traders who buy today and sell tomorrow - or sell tomorrow and buy a number of days later.

Interestingly, despite the fact that from an investment point of view Reliance has emerged as a highly notorious stock, it has not deterred speculators from making it an index of the market's health.

This is because speculators, more than any other segment of opportunists, realise that the big thing about Reliance is that it is a market deity worshipped by one and all, independent of the fact that it has not benefited the buy-and-hold player.

The result is that even though political upheavals affect Reliance less today than 10 years ago, Reliance's movement pictures the health of the market faster than most stocks.

The more you think about it, the more you will find it illogical as to why this should be. But it works and the only answer you can emerge with is that of liquidity.

Reliance is a traders' favourite because it is highly tradable. That simple.

How then does a stock become liquid? Assuming that the role of corporate performance in the pricing of a stock is 60 per cent, what do you do with the rest to improve discounting?

One. A better communications strategy is an answer - but an incomplete one. You can induce a number of analysts to buy the stock on the basis of the kind of language that one uses in the annual report; the regularity with which investors and potential investors are kept informed and the transparency with which the corporation in question is willing to face analysts in bad years.

Two. If foreign institutions reshuffle their portfolio from the weak to the sound, increased trading could be triggered.

Three. Corporations must be permitted to appoint their market makers.

Four. Bank credit for market makers and stock brokers could spur trading volume.

This is all very relevant. The Indian stock markets are going to see their biggest revolution in this area in the coming years. The NSE is going to spread to 200 towns and cities.

Every street corner is more likely to have a terminal from which one can trade than a paan shop. The country which had 20,000 jobbers and traders in the early part of this decade is likely to have 350,000 towards the end.

This will drive up the demand for liquid stocks in which to trade. As the market moves in quest for new counters which are under-researched and rightly capitalised, the big question is: Will the corporations grasp this opportunity of increasing their visibility by becoming more credible and marketable to investors?

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