The Hindu Business Line : Voter-investor discord

THE stock market has been unkind to the new government. The S&P CNX Nifty has been down in eight of the last 15 days. During this period, the market saw the largest single-day fall of 13 per cent. Such stock market behaviour brings to the fore two questions: One, is there a dichotomy between the voters and the investors in stock market? If not, why is the stock market unhappy with the new government? After all, people voted this government to power, and it is the people who are the investors in the stock market as well. Two, is it the responsibility of the government to "talk up" the market?

Politics and economics: The discord between the voters and the investors may be, perhaps, because of the concentration of wealth in the stock market. The four metros account for 75 per cent of the turnover in the stock market. It is enough even if investors in Mumbai are unhappy with the new government. They account for 40 per cent of the total turnover. And they may not be the ones who voted this government to power. The mandate to grant the new government power came from across the country.

Another explanation can be drawn based on public choice theory. This is a study that weds politics and economics. It states that the typical voter does not spend much time thinking about his choice of vote. He knows that his vote will not decide the outcome of the election. There is, hence, no personal incentive to execute a well thought-out decision.

But a new government can be elected because of the collective opinion of such disinterested voters. This perhaps explain the market crash even if the people who hammered the asset prices were the same ones who voted this government to power.

Financial versus real markets: Financial markets no doubt form an integral part of the economy. It is, therefore, the responsibility of the government to design a market microstructure to ensure efficient trading in assets. This does not, however, mean that the government is responsible for daily movements in asset prices. Nor can it be responsible for the losses that investors face when the market passes through a period of extreme volatility.

The Nifty index currently clocks a daily volatility of nearly 5 per cent. If the crash of May 17 is excluded, the daily volatility is 3 per cent. That is high by any standards. But such volatility is due to the behaviour of the tens of thousands of people who trade based on their expectation of the government policies and the perception of asset values. The Union Budget will be the first high-level policy initiative from the new government. Till then, the market will run based on expectations.

It is moot if the market would have behaved differently had the previous government been voted back to power. After all, the commodity price cycle is down, crude prices are up and China is applying brakes on its economic growth — all negative factors that can push the most vibrant stock market into reverse gear. Of course, the market crash of May 17 may not have happened.

But it is still not the responsibility of the government to "talk up" the market. In any case, the market cannot be "talked up" for long. Traders need policies in place to value asset prices. The government will do well to set rules and regulations to ensure smooth functioning of the economy, which includes the financial markets. A vibrant primary market is after all needed to raise money for green-field projects. But such a market will be virtually non-existent unless we have a thriving secondary market.

The daily aberration in asset prices is the risk that an investor has to assume before he enters the market. Expecting the finance minister to "talk up" asset prices is not correct.

If the asset prices trade away from their perceived values, bottom-fishers will automatically enter the market. Investors are governed by bounded rationality. Extreme price movements are the way of the market. Expecting exogenous factors to stabilise such behaviour may unsettle the market microstructure.

(Feedback can be sent to bvenky@thehindu.co.in)

More Stories on : Stock Markets | Insight | Mark To Market

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Auction the spectrum

Economic consequences of the CMP

US dollar resumes its long decline

14th Lok Sabha: Mix of youth and experience

Tainted Ministers

Towards an organisational economy

Voter-investor discord

Push hard for quality FDI

Mardia Chemicals clarifies

I-T sops for exporters