Politics, Stock markets and a tale of monkeys

Politics, Stock markets and a tale of monkeys

There is an interesting story about stock markets that was emailed to me from a business school buddy. It goes like this.

Once upon a time, a man announced to the villagers that he would buy monkeys for Rs10. The villagers, seeing many monkeys around, started catching them. The man bought thousands at Rs10 and supply started to diminish. He later hiked the price to Rs20 and villagers started catching monkeys again. As the supply disappeared, the man announced that he would buy monkeys at Rs50. However, since he had to go to the city on some business, he said his assistant would now buy on his behalf.

In his absence, the assistant told the villagers, “Look at all these monkeys in the big cage that the man has collected. I will sell them to you at Rs35 and when the man returns from the city, you can sell it to him for Rs50."

The villagers took out all their savings and bought all the monkeys. They never saw the man nor his assistant again, only monkeys everywhere.

This story seems to accurately reflect how big market players made a monkey out of small investors. The Indian stock market has seen huge volatility over the past few weeks.

The benchmark index of the Bombay Stock Exchange, the Sensex, witnessed a 5,000 point surge from 13,870 on 22 August to an all-time high of 19,059 points on 15 October. The continued flow of foreign money into India ever since the US Federal Reserve cut interest rates on 18 September has given a sudden jolt to the equity market.

The entire nation celebrated the rise of market by Sensex by over 1,000 points in just four trading sessions on 15 October. This made the finance minister raise an alarm. On 15 October, P. Chidambaram said that the steep rise in the stock market surprised and worried him.

At a time when the nuclear deal stand-off continues to raise concerns of political stability, Chidambaram was trying to protect the “aam nirveshak" (average investor), who was beginning to plunge headlong into the market all over again to participate in the stock market boom.

Chidambaram was also trying to save his skin, lest the government be blamed when the market dropped.

There are an estimated 7-9 million investors in the Indian stock market. This number has grown steadily over the years, thanks to tax breaks provided to individuals up to a maximum of Rs1 lakh for investments in equity-based mutual funds and tax incentives for individuals and corporations in the form of waiver of long-term capital gains tax on investments exceeding 12 months. The superior returns offered by the stock market have also made investments in equities popular with the middle class.

While ordinary investors lack the wherewithal to understand how markets are likely to behave, stock market analysts do not seem to know any better. They are wiser after the event, peddling a lot of analysis after the market’s rally or a meltdown. Never mind, that they told you exactly the opposite the day before.

For good measure, many analysts stay out of the stock markets themselves for their personal investments, fearing a meltdown, even as they offer non-stop advice on leading business television networks about India’s growth story, its undiminished potential, and attractive valuations even at astronomical prices.

Small investors have suffered heavily on all previous occasions when the markets crashed. But unfortunately, public memory is short and the greed among investors for making a fast buck is very strong.

The 1993 stock market crash hurt the ruling Congress party dearly. It lost a series of state elections in the period between 1993 and 1996, culminating in a big defeat in the 1996 general elections.

The Bharatiya Janata Party (BJP)-led National Democratic Alliance also had its share of woes. The UTI scam hit senior citizens and capital protection-conscious investors hard. Most of the people who invested in US 64 thought that it was as safe as bank deposits, but ended up losing their savings.

Despite the bailing out of UTI by the then NDA government, the BJP did very poorly in its urban strongholds and metropolitan seats.

The stock market not only influences election outcomes, it also reacts to election outcomes. A change of government at the Centre in 2004 was greeted with a huge slump in the market as it reckoned that dependence on the Left parties would slow implementation of economic reforms. It plunged more than 565 points (11%) in a single session on 17 May.

Interventions by the finance minister and the Securities and Exchange Board of India were timely and prevented many an investor from suffering the plight of the villagers in the monkey story.

However, knee-jerk reactions are not a solution to protecting their long-term interests. What the government needs to put in place is a stringent and proper regulatory framework that prevents real-life monkey stories.

G.V.L. Narasimha Rao is a political analyst and managing director of Development & Research, a research and consulting firm. Your comments are welcome at thebottomline@livemint.com