There is euphoria and a sort of enthusiasm bordering on madness in the stock market. The traditional view is that the stock markets are the barometers of the economy. It is expected that the markets and its indicators in the form of indices are to reflect the future potential of the corporates listed on them and in the process about the future of the economy. If the economy is performing well and is expected to grow at a healthy rate, the markets are expected to reflect that.

Not any more. Globalisation has changed all that. The day trader in Guntur or Kamrup has to worry about subprime foreclosures and yen carry trades. He has to read the lips of the chief of European Central Bank and understand the nuances of the speech given by US treasury chairman. The world has become surreal.

Unfortunately, this globalisation seems to be a one-way street. We are integrated with the global market and influenced by the developments taking place in Alaska or Adelaide, but our markets do not have any influence on the global markets. We do not see news regarding Dow Jones affected by Mumbai meltdown or FTSE impacted by Delhi tantrums.

Hence, this mating dance between our markets and others is extremely dangerous, particularly for the financial illiterates who are large participants in day trading.

In our markets, even though the listed stocks are above 8,000, we find that only around 250 or so are actively traded. Of these, the top 10 securities constitute nearly one-third of the traded value, indicating the level of skewness. In many matured markets, normally no single security has more than one percent of the traded value.

This skewness makes the market illiquid since everybody wants these 10-or-so scrips and when people exit, they also exit from these ten. Our markets are very skewed and shallow and to that extent, the role of the foreign institutional investors becomes important. Though in aggregate terms they constitute a small portion of the market, they play an important role at the margin level.

Institutional investors, particularly FIIs, are in search of better returns on a 24*7*365 basis. The fund manager is paid based on upon his performance and his job is to move funds on a continuous basis. Global funds have to think of geographical allocation and then asset allocation between risky shares and riskless government securities and the portfolio allocation among different shares. The fund manager is accountable only through his profits and he is not emotional about a developing country or a developed country or between European and Asian markets. If parking funds in Antarctica can make gains, he will do so with as much vigour as he would in Wall Street or Dalal Street.

It is known that a substantial portion of our market participants are day traders who square off the transactions daily. They can also be called margin players. Individual investors only do this since institutions cannot square off within a day in our system and they should settle transactions on a gross basis in the t+2 format. Actually, we do not know about the aggregate margins provided by individuals to brokers and the financing of these transactions, since currently the relationship is between the exchanges and brokers and exchanges pull the plug -literally - if brokers have not paid the margins or crossed their limits. Substantial portion of these transactions, between the individuals and the brokers are financed by the non-bank financial sector including individual moneylenders.

The markets cannot be talked up or down, as it is popularly believed. If the government tries to artificially push the market by encouraging its financial institutions to buy in the market, then it will be a folly of the highest order since public institutions like banks and LIC will be saddled with papers not worth talking about. Neither the enthusiasm of “experts” regarding the “robustness of our economy reflected in the increasing index” nor the complaint that “the fall in index is manufactured” is justified.

Coupled with this is the enthusiasm of Indian corporates to global money. In the last two years, the appetite of large Indian corporates for external commercial borrowings has been very large. ECBs had shown an additional flow of more than $13 billion last year and interestingly, the top 10 companies, including Reliance Petroleum ($2 billion), Reliance Communications ($1 billion), Tata Steel ($0.8 billion), Reliance Industries ($0.8 billion) and Reliance Energy ($0.8 billion), constitute more than 30% of the ECB approvals/registrations in the later period. This shows that corporates are increasingly looking at external sources due to lower cost and to that extent, developments in the global markets affect their ratings. Also, the major global borrowers have substantial importance in our indices.

We have arrived at an interesting situation in the development of our capital markets, wherein they are significantly influenced by global developments because of the active participation of FIIs — at the same time, big Indian corporates are showing appetite for global borrowings and not for domestic debt due to interest rate arbitrage.

In such a situation, we will find that the stock markets in India are increasingly disconnected from our domestic economy, which is expected to grow at more than 9% in the years to come. Already, there exists a disconnect between the government and the society, and now, this new disconnect between the economy and stock markets. Domestic economy is not moving the market but the tail (markets) is attempting to wag the dog.

As far as the stock exchange index is concerned, it can also move up if the Swiss banker decides to adopt more rigorous procedure in continuing existing accounts under the new ‘know your customer’ rules, further proving the disconnect with domestic economic activities.

vaidya@iimb.ernet.in