The worst may be over for markets, but one should wait

Sharp fall early last week was largely due to selling of shares bought with bank loans.

Last week was a veritable roller-coaster ride on the Indian stock exchanges. The Sensex fell like a brick in the first three days and soared like an eagle over the next two. Nerve shattering drops in the index of 334 points, 413 and 133 in the first three days saw it go to a low of 8,799, which seemed like Kanyakumari to an investor who had witnessed the Kashmir of 12,671 just 34 calendar days ago. It greatly shook his faith in the continuation of the Indian bull story.

His faith was restored over the next two days, when the market climbed a whopping 615 points (the highest, ever) and a further 339 to end the week at 9,884, up 74. It seemed like Sehwag had suddenly come into form!

The fall over the first three days was largely caused by banks selling shares they had lent under the ‘Loan against shares’ scheme, which turned out to be more like groan against shares for distressed borrowers. The selling pressure was thus an involuntary one, and any buying that emanated would see the selling stop. That is what happened as people saw value at lower prices. According to ASK Raymond James, the market was quoting some 13.5 times 2007 earnings for Sensex stocks, and 11.5 times for the top 100 stocks. Surely not an overvalued market as some foreign institutional investors (FIIs) would lead us to believe!

The sharp correction would be useful if both investors as well as the authorities derived lessons from it and took steps. Investors must, of course, learn that it is never wise to over leverage positions and to always remember Newton’s law. The authorities must learn that it would be sensible to allow speculation by individual investors, as this is healthy for the market, especially given the strictness with which mark-to-market margins are collected.

The India story is still an attractive one, driven by the demographics of youth and the aspirations of a large middle class population. With growing discretionary spending power, people who have long been denied goods of any quality have now obtained it, thanks to competition. What puts brakes on the story is the quality of our polity and its inability to take sensible action.

A survey of business in India (The Economist, June 3) talks about how it takes eight days for a truck to reach from Kolkata to Mumbai. It has to spend 32 hours at various check points, to pay state taxes and does the journey at an average speed, thanks to these stoppages, of 11 km/hour!

These stops are but one manifestation of how we, as a nation, are able to inflict economic damage on ourselves. Stripped down to the bone, both centre and state governments are unable to control expenditure but, instead, find myriad ways in which to tax people to death. The largest chunk of tax revenue goes into servicing debt, on which the government spends more than on defence, or on infrastructure or on education. On infrastructure, India spends 3.5% of GDP while China spends 10.6%. Without adequate infrastructure there will not be enough growth in the manufacturing sector to create the 70 million jobs needed to absorb new job market entrants over the next 10 years. So, if the government had any common sense, it would sell assets (public sector companies) for which the debt had been built up. The borrowing cost to acquire the assets are much higher than the return the government is able to generate. And even in the case  of those assets where it has been able to generate higher returns (the oil companies), it is now slowly destroying them, thanks to dubious politics.

Unable to control expenses, the government finds innovative ways to raise taxes. In the telecom sector, it now proposes to not only auction spectrum (which will make consumers pay the cost) but also levy a ‘service tax’ on interconnect charges! This is extortion! What service is the government providing to allow networks to interconnect? Unless the body politic gets its act in order and seriously plans for the future, the bull run will end much before it ought to.

The correction seems to be over, although the market could move sideways to lay the foundation for the next upmove. Buying on dips is recommended.