Commentary/Yazad Darasha

The stockmarket is unable to decide whether to be a bull or a bearcub

If the stock market says so, it must be so. How valid that statement can be has been demonstrated once again by the behaviour of the market in the last two years.

First the stock market predicted a corporate slowdown. So it fell to rock bottom and remained there. Then it mooched along for a long time at the bottom, desperate for news or indicators that would give it a boost. Finally, it fairly zipped to a two-year high in the beginning of January 1997, and looks good to crest another peak.

What is the good news that has given the market the rocket fuel to send it soaring? Could it be that it expects the 1996-97 financial year-end results from the corporate sector to be astoundingly good? One can hardly think so. Industry is still reeling from the effects of the 1995-96 cash crunch.

Let's look at some history here. By the time industry was halfway through fiscal 1995, the cost of funds had become skyhigh. Real interests rates of 35 per cent and over were being charged by the lending institutions and banks, and that too only to select blue-chip clients. There were no funds forthcoming for new projects, expansion plans -- the works.

The biggest culprit for this crunch was the stock market. At least, that is what everybody proclaimed. To an extent, this proclamation was valid. The market for primary issues had disappeared down a gaping hole in the trading floor, with even the best of IPOs given the cold shoulder by investors. But what was not valid was that the market was to blame.

The market has merely seen the signs. One, the real estate market was overheated and ready to incinerate investors. Which means the impending collapse would leave a lot of the moneybags (including medium and small companies) without ready cash. All the real estate holdings would become pieces of paper until the market found a much-needed equilibrium.

Two, companies and their merchant bankers were happily taking the investor for a ride by misusing their freedom to fix a premium on their new equity issues. When the market gave all these overpriced shares their true worth by quoting them below issue price, the investors began screaming blue murder. Who was the murderer? Was it not the same corporates who then felt the crunch as the stock market collapsed?

Three, disposable incomes were increasing among the middleclass by leaps and bounds, investible resources among institutions -- even the public sector ones -- were overflowing into the corporate coffers of any promoter who came along and could slice himself some of the pie, using good old palm grease as the lever.

A logical end to this -- which the market foresaw -- would be a massive pile-up of non-performing assets with these institutions, resulting in a slowdown in lending, prompted by the threat of CBI investigation. So interest rates were bound to rise, making investment in shares that much more unattractive.

These are some of the signs that a blind man could have read, had we bothered to look unprejudicially at the events unfolding in 1995-96. Unfortunately, hindsight is the only form of 20-20 vision. But having seen clearly in hindsight, let's try to look ahead with the same clarity, without prejudice, and again using the usually steady eyes of the stock market.

You will say that there is no reason for the stock market to rise as it is doing. Corporate results are still expected to be bad, the GDP growth is not really on track, unemployment is rising... However, all these are the signs that the market saw more than a year ago, which is why it fell! What the market is looking at today, is the likely status a year from now!

So what is this good news that the market is trying to impart to us? Here is a possible scenario:

Already signs of a cooling off on the interest rate front are evident. The Industrial Development Bank of India's Flexibonds 2 offered a rate of just 15-odd per cent as compared to the 18-odd offered on the first instalment. A large quasi-government telecommunications monopoly recently made a debt offering at 14 per cent. The Prime Lending Rates of most banks, starting with pack leader State Bank of India, have been reduced by two percentage points in the last three months.

Another pointer on the interest rate front is that the institutions' borrowing rates are lower for long-term instruments as compared to the short-term offers, implying that they foresee money becoming cheaper in the long run.

At the same time, the finance ministry and the Reserve Bank of India have been taking positive steps to ensure that there is an increased inflow of funds into the capital markets, and thereby into industry (hopefully, if the primary market picks up along with the secondary market). The reserve ratios for banks have been cut, banks been asked to invest in stocks via the Unit Trust of India, and broad indications have been made that there will be a resolution to the thorny issues of Minimum Alternate Tax and double taxation of dividend income.

And of course, the real estate market appears to have found its equilibrium.

All this implies that industry and the corporate sector are in for a rosier 1997-98. This is reinforced by the analysis that although there was a drop in income and profits during the two years 1995-97, given the constraints of costly capital and higher tax outgoes, industry has still managed to hold its own, and not posted negative growth.

Then should we start turning cartwheels out of sheer joy? Well, it might be prudent to wait. Because two flies in the ointment jump out at us for attention. One, if institutions and finance companies have borrowed at such heavy rates of interest in the last one year, how will they manage to lend at lower rates and still stay afloat?

Two, if the small investor who, in his enthusiasm, has put a lot of money into finance companies offering phenomenally high rates of return, finds the weaker of these companies quietly folding their tents and stealing away into the night, won't that mean that much less inflow into the capital markets?

Perhaps the market has already thought of these factors. That is why it is seesawing so much, unable to decide whether to be a bull or a bearcub. Let's look at these factors in greater depth next week.

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