Sensex stress

Updated on: Apr 02, 2014

The meteoric pre-poll rise calls for an investigation

There’s more to the recent Sensex surge than meets the eye. It is out of sync with India’s economic slowdown. There isn’t that much quantitative easing money sloshing around. Are the markets punting on Modi?

Modi is only a frontrunner; the contest is still wide open. So, contrary to media reports, Modi cannot be the sole reason for the rise in FII interest. Market observers attribute the higher FII flows in 2013-14 into both equities and debt to the following: a cheap rupee making assets attractive; a high interest rate making debt worthwhile; and bottoming out of the business cycle (this is a hard one to swallow). The first two factors appear valid, but that does not explain the timing of the rise — why do stocks go through the roof in the months leading up to an election, a feature of both 2004 and 2009?

The bull run is better explained by the round-tripping of funds through FIIs for use in the elections. Pre-election market rallies are characterised by high volumes, and were largely equity-driven in 2004 and 2009. Therefore, March 2014 has seen FII inflows of ₹87,947 crore and outflows of ₹67,689 crore, the inflows being nearly twice the amount in February and the outflows nearly 1.5 times more. The latter suggests the encashing of funds by benami entities (read politicians) while the FII books point to ‘outflows’.

There was also a near doubling of equity trade volumes between December and March 2004. While the situation was different in 2009 because the markets welcomed the fiscal stimulus, the mid-year buoyancy was also on account of the polls. This gives rise to two questions: the route through which these funds enter and their economic impact. While participatory notes (PNs) were in vogue between 2003 and 2008, accounting for over half of FII flows, these are down to about 12 per cent. Has black money opted for the sub-accounts route after tighter norms for PNs came into force? SEBI does not provide ready data on sub-accounts. An inquiry into what’s going on is in order.

Now, to the larger issue: Even if one assumes that these flows are legitimate, they could leave the country soon after the elections. The effects of hot money flows on the exchange rate, and therefore on jobs, can be serious. Time then, for a really stiff securities transaction tax, or Tobin tax.

Senior Assistant Editor

Published on April 03, 2014

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