http://www.thehindubusinessline.com/2005/04/07/stories/2005040700300800.

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Abhimanyus of the financial markets

Thursday, Apr 07, 2005

R. Vaidyanathan A financial market with a million Abhimanyus, who cannot exit, is a poor showpiece for global participants. It is important to rework the financial architecture to reform the illiquid stock market and integrate domestic credit markets, evolve a single yield curve and enhance the capability of participants to enter and exit the market any time. Such a reworking is required before there is talk of integrating the domestic markets into the global financial system, says R. Vaidyanathan. THE facility to enter and exit at all points of time is one of the critical parameters by which markets are measured for their efficiency and effectiveness. Here, we are not talking about making gains or losses but of the liquidity of the market and widespread participation. Entry barriers can be overcome by regulations and sometimes even by `reservations', but the ability to exit the market is not easy to achieve by government fiat. What the experts otherwise call market timing may not be possible if exit is not easy for any reason. The financial markets, particularly the share bazaar and the unorganised credit market, suffer from this Abhimanyu syndrome. The former relates to investors and the latter to the lenders. Small investors are now the cynosure of all eyes. Tomes have been written on how to woo them back into the share market. A large number of industry associations have offered a plethora of ideas on how the stock exchanges can attract the small investors once again. The so-called small investors are the children of the Controller of Capital Issues (CCI) raj. In the early 1990s, the CCI used to fix share prices and allow FERA companies to offer stock in the market at those artificially fixed low prices. Investors used to apply for these shares under different names, only to offload them in the market at exorbitant prices after listing. In the process, several fly-by-night operators also floated companies and took advantage of the boom of the early 1990s. The Harshad Mehta affair was only a part of that story. An important feature of the period was that the stock exchanges reckoned only the listing fees while listing companies, and not the other fundamentals. Later, of course, the Securities and Exchange Board of India (SEBI) formulated guidelines governing the listing of new and existing companies in terms of their track record and other parameters. These investors who entered the market during those halcyon days are unfortunately not in a position to exit now, even at a loss. As we are familiar, in the Mahabharatha during the Great War, Abhimanyu, a son of Arjuna, knew how to enter the Chakra Viyuha. Abhimanyu met his nemesis because of his inability to come out of the formation made by the Kauravas. For the benefit of the MTV generation, Abhimanyu heard the art of entering the Vyuha when he was in his mother's womb. But before he could hear the exit technique, he was born. He could not double-click on a mouse then. The plight of these investors is due to a four-fold problem in the market. The stock market is very illiquid. This means that there are no takers for most shares at any price. Though nearly 9,000 scrips are listed on the exchanges, more than half were not quoted or traded last year. Another 25 per cent was quoted only a couple of times last year. The shares of only 5-10 companies commanded more than 40 per cent of the trade turnover.

Contrast this with the New York Stock Exchange (NYSE), where no single scrip normally enjoys more than one per cent of the turnover. Though market players and exchanges shout from the rooftops that India has the largest number of scrips listed (like having the largest cattle population in the world), only around a hundred are active. Actually, last year, out of the nearly 9,000 scrips only 2,600 were traded at least once. If you hold the wrong scrip you can only use it as cattle feed!

Around 25 per cent of trade at the NSE resulted in actual delivery of shares in the last year (Table). This implies in a sense that substantial amount of transactions are for squaring off on the same day. Day traders practise this. One can infer that there is a high level of speculative activity in the market. Even the remaining portion of the delivery is mainly by institutional investors since they have to take delivery or make payments. Small investors do not figure in all this. Exchanges should publish detailed and separate statistics about the trade done by brokers on their own accounts and trading by them on behalf of clients. This will be very revealing. It will lay bare the fact that most of the trading is being done only on their own accounts by the brokers. In well-organised markets, there is a system of marketmakers who offer two-way quotes on any scrip, so that continuous liquidity is provided to all scrips. We do not have this facility. The merchant bankers and brokers are significantly under capitalised to perform this role. A company should not get listed unless market-making is assured for its share. The lack of this facility is the noose around the neck of the small investors. Several expert groups from SEBI, the Bombay Stock Exchange, the Institute of Company Secretaries, the Department of Company Affairs, etc are now searching for companies that are not traceable. Above all, small investors do not have timely protection against non-payment or non-delivery of shares by brokers. If a broker defaults, then the matter has to go through a process of being heard by an investors' grievance committee, then an arbitration committee, a default committee and, finally, the auction of the defaulting broker's membership card. This rigmarole can take two-three years if the investor is lucky. Justice hurried is justice buried all right. But the harried investor gets buried much earlier. There are other twists to the tale. If the broker has shown the amount received from a client as a loan and not as an advance for buying certain shares, then the stock exchanges will not even hear the investor's grievance under the pretext that it is outside their purview. Contract enforcement is cumbersome and time-consuming. Why, then, do we enthusiastically lure small investors to such a speculative, illiquid, unprotected and opaque den?

Why encourage small investors and give them false hopes? Of course, the goat is always well-fed and treated with care before it is sacrificed. It is also not afforded the luxury of free expression of its opinion on the matter!
Credit market

In the unorganised credit market, the lenders are like Abhimanyu. They are not in a position to re-possess the unsecured loan they have advanced to any trade or other businesses. If the lender is an unincorporated body, then it does not have the protection of recovery tribunals or asset reconstruction agencies. Lending is based on the `relationship' with the borrower rather than on detailed legal documentation. Under the circumstance, the lender tries to take recourse to extra-legal mechanisms including engaging "collection agents" to get his money back. In such a situation, the capability of the lender is eroded and recovery mechanisms distort the risk-return relationships. Evolved credit rating mechanisms, coupled with the active participation of the commercial banker in accommodating the unincorporated bodies as channel partners, could to some extent ameliorate the situation. It is important to rework the financial architecture to reform the illiquid stock market and integrate domestic credit markets, evolve a single yield curve and enhance the capability of participants to enter and exit the market at all times. Such a reworking is required before we talk in terms of integrating the domestic markets into global financial markets or chanting the mantra of making Mumbai the global financial hub. A financial market with a million Abhimanyus is a poor candidate for being shown as a showpiece to the global participants. The global players may even try to take advantage of such a market, which might only create larger issues for household investors and other unincorporated lenders in the years to come. (The author is Professor, Finance and Control, Indian Institute of Management, Bangalore, and can be contacted at vaidya@iimb.ernet.in. The views are personal and do not reflect that of his organisation.)