The Hindu Business Line : Towards sustainable stock market liquidity

Given the superior performance of equities over other asset classes over long periods of over ten years, domestic investors have no choice but to step up their exposures to stocks. Over the years, if they increase their allocation to equities, domestic mutual funds and insurance companies will become bigger investors than FIIs.

A DEPRECIATING rupee and a public offer proposal for Rs 7,000 crore is all it takes for investors to realise they are skating on thin ice.

The depreciating rupee, that has instilled the fear of FII withdrawal, and ICICI Bank's proposed public offer have focussed attention on liquidity, or the lack of it. This has led to stocks suffering their worst week in the past six months.

The prospect for liquidity is, however, not at all bad. There is plenty of money waiting to be invested and the money waiting does not belong to the FIIs. For 10 years now, domestic investors have not been investing in the secondary market for stocks.

They may have no option, though, but to enter the equity sweepstakes eventually, and that time may be upon us now.

On the sidelines: In the past 10 years, FIIs have pumped in close to $40 billion, or Rs 1,60,000 crore, in the Indian market.

This represents the money that has been taken out by domestic investors from the stock market. Between June and September this year, domestic investors have taken out close to Rs 22,000 crore while FIIs invested a similar amount in the market.

While the FIIs were attracted by the Indian growth story, Indian investors have chosen to remain on the sidelines. Even the biggest rally in stock market history has not forced them to change their term-deposit-investing ways.

Term deposits of the banking system are now at about Rs 18,56,000 crore, and households own nearly 60 per cent of this sum — about Rs 11,00,000 crore. Stock market capitalisation is about Rs 20,00,000 crore, and households may barely hold 15 per cent of this sum, or about Rs 3,00,000 crore. The value of public holding in stocks approximates this sum.

If we consider other assets such as cash, LIC policies, small savings, provident fund dues and, more important, real estate, proportion of equities in total investment pie would be far less than 10 per cent. The total investment in each of these asset classes every year is higher than that of the stock market investment.

For instance, every year, out of their annual income, domestic investors hold cash worth Rs 40,000 crore. Investments in equities on the other hand have been negative.

Given the superlative performance of equities over other asset classes over long periods of ten years, this situation is not meaningful. Domestic investors have no choice but to step up their exposure to Indian stocks.

This may already be happening if subscriptions to mutual fund investments are anything to go by.

In the past two months, investments in equity schemes have exceeded Rs 6,000 crore. More is likely to be in the pipeline as the equity cult takes wings.

Liquidity rally: So imagine a situation in which every year households invest Rs 30,000 crore and FIIs bring in another Rs 30,000 crore to the party. Liquidity in the stock market would be sizeable.

Even if fresh offers such as those of ICICI Bank take out close to Rs 20,000 crore from FIIs and households, there will be plenty left to invest in secondary markets.

Over the years, if domestic investors set right their exposure to equities then domestic mutual funds and insurance companies will become bigger investors than FIIs. As such, going forward, FIIs alone may not move the markets.

In this backdrop, concerns about liquidity appear overblown. There is enough liquidity around.

If you are not hankering after 20 per cent plus returns, there are also enough investment-worthy stories that can fetch attractive annual returns of 10-12 per cent over the long term.

The Indian economic growth story also rests on strong fundamentals. As such, any fall in stock prices triggered by expectations of waning liquidity is an opportunity to buy.

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