India's Missing Investors

Date : Apr 9, 2015

By Dhiraj Nayyar

If Prime Minister Narendra Modi has delivered one thing in his first ten months in office, it's been electricity to India’s stock markets. India’s benchmark Bombay Stock Exchange (BSE) Sensex recorded a 31 percent jump in 2014. Only the insane runup in Shanghai's bourse -- up 90 percent in the past 12 months -- has overshadowed the Indian rally.

Unfortunately, very few actual Indians stand to benefit from the boom. The proportion of retail investors in India’s equities markets is strikingly low. Less than 1.5 percent of the population invests in securities, compared with almost 10 percent in China and 18 percent in the U.S. Just 2 percent of India’s household savings are exposed to equity; in the U.S., the long-term average is 45 percent.

This is ultimately bad news for India’s economy. The country desperately needs to channel more household savings into equities -- which are a vital source of corporate finance -- and away from unproductive investments in gold and real estate. India also needs more local funds if it's to sustain the strength in its equities market while avoiding macroeconomic imbalances. At the moment, around 70 percent of the market is dominated by foreign institutional investors.

Consider this statistic. Between September 2008 and October 2014, those foreign investors made net purchases of $45 billion. In the same period, domestic institutional investors (mostly funded by retail investors) made net sales of $16 billion. This imbalance creates serious side effects. The billions of dollars flowing in produce upward pressure on the rupee and a decline in India’s competitiveness. When they flow out, usually at short notice, markets collapse and the exchange rate grows volatile. That scenario is almost certain to play out in coming months when the U.S. Fed tightens monetary policy.

At one level, the reluctance of retail investors doesn't make sense. Despite quite normal ups and downs, India’s markets have done well over the last decade. The Sensex gave a return of 17 percent compounded annually between August 2004 and August 2014. That's twice as much as Indians earn from their most preferred mode of financial savings: bank deposits. Yet the proportion of retail turnover to total turnover actually declined from over 80 percent in 2003 to under 35 percent in 2013.

What accounts for the disillusionment? For one thing, retail investors may not have earned the average rate of return. Like mom-and-pop investors in other countries, most notably China, India’s punters don’t always make the best buy-and-sell decisions. They usually sell high-performing stock earlier than they should and hold onto badly-performing ones too long. They also tend to enter stock markets near their peaks and quickly lose confidence when they fall. Also, the one market which usually attracts retail investors in larger numbers -- the market for initial public offerings -- has performed poorly in India over the last decade. An analysis of 394 IPOs between 2003 and 2014 found that only 164 companies were trading over their offer price. Thus, 60 percent of investors lost money over a decade.

There's also a lingering perception that India’s stock markets are manipulated by a few big players; markets have been marred by several high-profile scams in the last two decades. While India’s stock market regulator has done a reasonable job of reining in malpractices, confidence still lags. Also, India’s dominant family-run companies, as well as listed public-sector companies, need to offer more of their stock to the public to add depth to what's traded and to make manipulation harder. Many have struggled to comply with the requirement that at least a quarter of shares be publicly held.

The development of a robust Indian equity market after 1991 represents one of the great achievements of India’s liberalization policies. To reap the full gains, though, the government now needs to do a better job of educating and enticing its own citizens into taking part.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

Source And Courtsey By :- http://www.bloombergview.com/articles/2015-04-09/india-stock-rally-needs-more-domestic-retail-investors