The great Indian stock market tumble

For months, until January 21, the Indian stock market defied gravity as other regional markets went down like ninepins. But then, like many other countries, India earned its own Black Monday. The Sensex, India’s major stock index, crashed by 1,408 points, the biggest one-day drop in the 133-year history of the BSE, Asia's oldest exchange. Since that time, the market has been gyrating, claiming as a victim the IPO of Reliance Power Ltd, whose shares subsequently nosedived, wiping out billions in market capitalization.

"Blood on Dalal Street," screamed newspaper headlines and TV grabs, referring to the Indian equivalent of Wall Street. This was just 12 days after the Sensex had closed at its all-time high of 20,873.33.

Investor wealth of Rs6 trillion (US$151.3 billion) was wiped out in a single day. Only 139 BSE stocks rose while 2,657 – including the premier 30 that constitute the Sensex – ended in the red. Panicky foreign investors dumped shares worth Rs33 billion. Ramdeo Agarwal, co-founder and director of Motilal Oswal Financial Services Ltd and a highly respected market analyst, was quoted saying the slide was on account of valuations being stretched. "But things should soon stabilize," he added.

He was wrong.

Over the next three weeks the Sensex fluctuated wildly, falling sharply one day, rising the next. Then, more recently, it fell by 746 points on February 11, 2008, its third largest fall in a single day. "The Indian stock market's great bull run seems to be finally over," said economist Venu Menon.

Partly, the India is mirroring stock markets the world over affected by the sub-prime crisis in the US and the slowing American economy. But there is also the problem that, as has happened in China and other countries, it has become fashionable for the Indian middle class to dabble in stock markets. And, as has happened in other countries, few people seem to have been aware that markets can come down as well as go up.

Enticed by tales of neighbors making a killing, the average investor didn’t want to be left out. Discarding market fundamentals, too many people bought dubious shares recommended by sub-brokers or acted on "tips" handed down by the cousin of a friend whose maternal uncle works for a stockbroker. And when the market set in for a correction, the average Joe began to realize that his investment had tanked by 50 percent and that there was no way he could earn the 200 percent return he was lusting after. He panicked and sold, along with thousands of others.

The market slide was serious enough for India’s Parliamentary Standing Committee on Finance to call for a meeting of various regulators, market participants and exchanges to investigate the market volatility and declining indices. What they are learning should be fairly obvious.

The run-up in stock prices in the last quarter of 2007 was utterly irrational as money was being sucked out of the secondary market for deployment into large initial public offerings; foreign institutional investors were selling heavily and nervousness began to grow over the annual government budget.

Proof of this is the unexpected drubbing that Reliance Power received when its shares came up for listing on 11 February. That the company was a vehicle for the powerful Ambani family, India's richest, did not matter. Negative sentiment was over-powering.

India's largest ever IPO ($3 billion) had been oversubscribed 73 times, but after a brief opening spurt, the shares fell by the end of the day to Rs372.3, at a 17 per cent discount to the IPO price of Rs450. Following the Reliance Power debacle, two other big companies, Wockhardt Hospitals and Emaar MGF, quietly withdrew their IPO offers. Uncertainty in the secondary market had spread the gloom all around.

There are some who feel that the issues could have sailed through had they not been aggressively priced, which they were, the reason being greed on part of all involved – the companies, the lead managers, the merchant bankers, and, of course, investors. Some borrowed money heavily or sold off family jewelry in order to be a part of the action.

So why did it take so long for the impact to be felt by the Indian markets? You can't blame the market participants alone. The “intrinsic strength of the Indian economy” theory had caught the fancy of many converts.

India became a favored destination when the US Federal Reserve cut interest rates by 50 basis points in order to counter recession and released liquidity into the system on September 19, 2007. Much of that money found its way into booming economies like India’s.

Second is the continuing India story and its many positives: a domestic saving rate in the region of 25 percent; increasing salaries and purchasing power, especially amongst Indian youth employed in sunrise sectors like telecom, retail and financial services; low levels of borrowings by Indian companies; GDP growing at an average of 9 percent annually over the last four years and comfortable foreign exchange reserves ($284.9 billion as of January 18, according to RBI data).

But now all those sterling attributes have been swept aside by a tornado of pessimism affecting investors as well as market intermediaries at various levels ‑ so much so that the slide has crept from the secondary to the primary market.

So how long will it last? There are reasons to be optimistic once the chaos settles. Dividend income and long term capital gains are both tax-free. There is also talk that the government will allow pension funds as well as funds of public charitable trusts to enter the equity markets, providing more liquidity and broadening the market.

World confidence in India has also increased. Foreign institutional investors may move in and out of the stock markets but foreign direct investment in India should carry the country through any short-term downturn. Corporate India's ability to grow remains robust. This is true for the Indian economy as well.

It is now up to investors to eschew their earlier irrational expectations and instead settle for more acceptable – but still impressive – returns.