Vijay Kumar Gaba

Continuing from yesterday’s post, let me share my thoughts on the issues raised therein. 

If the condition of the economy is so bad, why are the equity markets booming?

In my view, there is nothing unusual or unprecedented in the current equity market behavior. We have witnessed markets scaling new highs during 1989-1994 (Sensex up 482%) when the global economy was struggling in the aftermath of the severe global economic slowdown; NATO forces attacking Iraq and a sharp rise in energy prices; India facing a severe balance of payment crisis, needing an IMF bailout; fall of National Front government in two and a half years and subsequently Chandrashekhar government within six months, and a minority government led by P. V Narasimha Rao at the helm in Delhi; first major financial market (Harshad Mehta) scam in India; belligerent BJP taking out Rath Yatra from Somnath to Ayodhya, Mosque demolition in Ayodhya and subsequent acts of terrorism that killed thousands; a slew of economic reforms causing the decimation of numerous MSME businesses. Commodities producers led the charge in this rally.

During 1999-2000, markets scaled new highs (Nifty up 42%) despite massive political uncertainties (3 general elections in 3 years); severe global economic sanctions post-1998 nuclear tests leading to sharp growth deceleration and capital outflows; LTCM default; sharp currency devaluation by Brazil, an Asian economic crisis; etc. The market rally was however very narrow, mostly led by IT services and the Internet.

The 2003-2007 market move was perhaps the most phenomenal (Nifty up 461%). Markets scaled new highs without any earnings growth. Corporate and lenders’ balance sheets worsened at an unprecedented pace – both in India and globally. The up move was much broader with consumers, financials, and capex all contributing in some measure.

The 2017-2024 market rally is remarkable in more than one sense (Nifty up 170% so far). First, it is perhaps the longest bull market in India. It survived the worst pandemic in over 100 years, rather easily. It has also survived, perhaps what could be termed the worst geopolitical crisis since the end of the Cold War. The leadership of the rally has rotated remarkably between a variety of sectors like consumers, financials, small and midcaps, capital goods, infra builders, realty, commodities, energy, healthcare, IT services, telecom & digital, etc.

My take on the current equity up move is:

1.    Equity markets have always looked for opportunities in the crisis. The markets are looking much beyond whatever is happening today. Of course, there will be intermittent corrections and crashes, but Indian equities are geared for much longer bull markets this time, regardless of the global conditions. We have seen similar secular bull markets in the US, Europe, Japan, etc. in the post-WWII era.

2.    The Indian equity market may be inching towards reality, i.e., rising income inequalities, stressed household finances, geopolitical uncertainties, and near-shoring and friend-shoring. The market is rewarding premium consumption, workforce rationalization (cost cutting), geopolitics (defense), local capex, manufacturing, and logistic infra, etc., and punishing staple consumption, savings, etc.

3.    The market is not expecting any significant disruption due to civil unrest or political changes.

…to continue tomorrow

A web series on the infamous Harshad Mehta scam of early 1990s seems to have triggered a debate on the present state of the financial regulation and risk management practices in India. The key point of interest is whether a scam similar to Harshad Mehta scam could recur!

During late 1989-1992, a Mumbai (then Bombay) based stock broker Harshad Mehta used the inefficiency and lacunae in the banking and stock market systems to create massive pseudo credit. The credit so created was used to manipulate stocks prices, causing the first major bubble in Indian stock markets. This was the time when Indian economy was struggling with unprecedented balance of payment crisis, political uncertainty and higher energy prices due to war between Iraq and US (an ally of Kuwait) in the Persian gulf. Given the despondent economic situation huge short positions were built by traders in Indian equities. In the summer of 1991 the Congress government led by P. V. Narsimha Rao assumed office and unleashed a slew of radical reforms. Using this pretext, Harshad Mehta squeezed the short sellers by using the pseudo credit he could manage by defrauding the nationalized banks. The bubble finally burst in April 1992 when the modus operandi of Harshad Mehta was exposed.

The immediate fall out the bubble burst were (i) promulgation of the Securities and Exchange Board of India (SEBI) Ordinance 1992 to establish an autonomous regulator for regulation of securities market in India; and (ii) up-gradation and modernization of interbank settlement system of government securities. SEBI immediately issued a slew of rules and regulation to regulate the operations of stocks exchanges and market intermediaries. The first fully electronic stock exchange (OTC Exchange of India) modelled on NASDAQ of US was established in 1992. A National Stock Exchange (NSE) was established in 1994, as a nationwide fully electronic trading platform. Establishment of NSE eventually led to elimination of floor based trading and closure of 27 of the 28 regional stocks exchanges. India thus became the first country in the world to have 100% electronic trading in equities. Later Depositories Act was passed to enable establishment of depositories, dematerialization of securities and settlement of trades in electronic form.

The improvement in trading and settlement systems; tightening of margining norms; tightening of compliance procedures to protect the interests of investors etc. have been a continuous process since then. Each instance of fraud & manipulation, accident, unethical behavior has resulted in some improvement in the regulatory process in past 28 years.

However, the continuous strengthening and tightening of regulatory has not deterred the manipulators, fraudsters, and unethical promoters & intermediaries from indulging in fraud and malpractices. The IPO and plantation companies frauds of 1994-1996, dotcom fraud (Ketan Parekh) of 1999-2001, Sahara public Deposit scam, PACL Chit Fund Scam, LTCG Scam, numerous cases of insider trading and front running by mutual funds and corporate officials, act of impropriety by mutual funds (e.g., Franklin Templeton, Kotak MF, Birla MF) etc kept rocking the market intermittently. In fact it has been a 28yrs long episode of Tom (SEBI) and Jerry (Manipulators) where both are consistently trying to dodge each other. Hence, there is no assurance that a Harshad Mehta like scam will not recur in Indian markets.

The best thing however is that Indian markets have remained amongst the safest in world in past two decades. We were perhaps the only market in India that did not impose any trading restrictions during global financial crisis.

The recent measures taken by SEBI and Stock Exchanges to tighten the margining norms to dissuade excessive speculation have been severely criticized by market participants. However, in my view, COVID-19 has warranted SEBI to consider Negative Commodity price and Act of Gods as White Swans for risk management system for securities market. I therefore expect even further tightening of margining and compliance norms.