STOCK MARKETS AND THE ECONOMY

STOCK MARKETS AND THE ECONOMY

THE INDIAN STOCK MARKET AND THE INDIAN ECONOMY

 

The Indian Stock market is once again in the lime light due to the runaway rise in the Stock Market Indices. This is not a new phenomenon but has been happening since the past few years.

 

The world economic crisis of 2008

The world economic crisis of 2008 and the huge financial scandal of Sathyam Computers in the year 2008 resulted in a humongous crash in the stock market prices which dealt a fatal blow to millions of investors.

 This crisis also showed the strength of the Indian banking system and the commendable role the Central Bank of the country viz. RBI, has been playing in monitoring and supervision of the Banks in India.

 Most of the world’s leading Banks were facing huge problems which also put the Western Countries and the USA in deep economic crisis.

Around the same time the Indian economy was also in a sluggish growth pace mainly due to the economic crisis most of the world’s leading countries were facing.

 The cash rich Foreign Institutional Investors (FII) turned their attention to India to safely park their funds in the Indian Stock Markets and also make a decent profit. Hence there was a phenomenal increase in the inflow of funds and the stock markets went to higher levels in spite of the prevailing dismal conditions.

 

Economic conditions and Stock Markets

The Stock Market is supposed to reflect the performance of the companies that are listed therein individually and also overall economic condition of the country’s economy. A company whose performance is good or expected to be good rises in value and in contrast those whose performances are bad or expected to be poor will fall in value. Most of the companies were not performing well due to local and international causes. The Indian economy was plagued by very high inflation and poor growth rates. In such a scenario the Stock markets in the normal course should have been very much at its lowest. However they continued to reach newer and higher heights. This was mainly because the FIIs were in the market pumping huge money as the Indian market was not only safe but also was yielding good returns. The huge inflow of these funds also affected the Foreign Exchange markets with the rupee appreciating against the major foreign currencies causing problems in the management of the rate of the rupee.

Further whenever the FIIs withdraw their investments both the Stock Market and the Foreign Exchange markets are affected causing ripple effect in the economy.

Thus it is seen that the Movements in the Stock Market is not driven by the economic conditions of the Country in general nor the performance or non performance of the individual companies.  It is the Investors and particularly the Foreign Institutional Investors who drive the movements in the stock markets.

 

How do Investments in Shares through Stock Markets affect the economy?

An important feature of stock market investments which is elaborated in the following lines is to be clearly understood.

  • Companies raise capital by issuing shares to the public. These are called ‘Public Offerings”. The shares are normally priced at a value above the Face value. The public purchase these shares during such public offerings directly from the companies which results in inflow of funds to the companies. These funds can be used by the companies for its various activities.
  • The shares thus bought can be sold by the purchasers in the stock markets.
  • The sale and purchase transactions that normally happen in the stock market do not result in any funds flow to the companies.
  • The operations in the stock markets do not benefit the Economic activity of the companies and therefore of the country except when shares are issued as public offerings.
  • The purchase and sale of shares in the Stock Markets only affect the funds of the purchaser and seller resulting in profit or loss to them.

 

Government Incentives for investing in Shares

The Government has given a lot of incentives for investors in the stock market like no tax on dividends paid by companies and Mutual Funds, carryover of losses, exemptions on taxation of Capital Gains, etc.

 

FII investments are like HOT MONEY

The funds from the FIIs are something like HOT MONEY since they are brought in and taken out at the convenience of the FIIs and are for very short periods only. They do not have any positive impact on the economy. However the harm they cause to the economy is very great. Hence there has to be some way of managing this flow of funds so that they do not disturb the general conditions of the economy.

 

Present Scenario

Now (in the year 2018) also the Stock markets have reached dizzying levels. The economy is still in a state of low growth, The Banking Institutions are beset with huge Non Performing Assets and many of the Companies are under performing. Though the rate of Inflation is pretty low the common man is not able to save much due to the past several years of high inflation.

So what are the reasons for the Stock Markets to reach higher levels? Even the Stock prices of Public Sector Banking Companies have increased.

We can only conclude that the reasons already mentioned above are proved true.

Thus even though the Stock Market Prices are not a barometer for the performance of a company or the country the Authorities like to link it to their governance and policies.

 

SUGGESTIONS for regulation of FII Investments

The flow of any foreign funds is to be welcomed as they are required for the growth of the economy.

Funds by way of Foreign Direct Investment should be encouraged as they are likely to remain for longer periods within the country with suitable restrictions on voting rights.

Investments by NRIs should be encouraged.

These funds are received directly by the companies which give a boost to economic activities.

 

The funds received by way of FII investment in the Stock markets should be accounted for separately in the following manner:

Whenever a FII wants to buy any shares in the Stock Market they have to surrender the Foreign Currency to the Authorised Bank. All Authorised Banks who receive such funds should surrender the Foreign Currency to the RBI. The RBI can fix a fixed rate at which they will reimburse the Rupee equivalent to the Banks. The Banks can have a margin and release the Rupee funds to the FIIs.

Whenever the FIIs sell their Shares and want to take the Foreign Currency out of the country they should surrender to the Authorised Bank the Rupee funds. The Authorised bank will buy the equivalent Foreign Currency from the RBI at a fixed rate and give it to the FII after retaining their margin.

Eg.

  1. When FIIs purchase Shares ( FC comes in)

RBI rate for purchase of FC from AB USD 1 = Rs.61/-

Less  AB’s margin                                                  Rs.1-

FIIs will get                                    per      USD1= Rs.60/-

 

  1. When FIIs sell Shares ( FC goes out)

RBI rate for sale of FC to AB                   USD 1= Rs.62/-

 Add    AB’s margin                                                 Rs.1/-

FIIs will have to pay                        per USD 1 = Rs.63/-

Thus the FC brought in and taken out by the FIIs will not be at the prevailing Market rates and hence they will not cause wide movements in the Foreign Exchange Markets.

Hence the Export and Import transactions of the country will be at stable rates and help the exporters and importers to manage their flow of funds better.

The RBI will also have a clear picture of the FII funds and hence can use them for short term purposes only. Further they would not be required to intervene in the Foreign Exchange markets, as they do now very frequently, to stabilise the exchange value of the Rupee.

The Funds would be accounted as in an ESCROW Account.

The conversion rates could be changed, say, once in six months to bring it more or less on par with the prevailing market rates.

The FIIs will also be knowing the Rupee equivalents that they will get or need to pay so that they can take appropriate investment decisions.

Author

Kaushik Vichar

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