The brutal power of liquidity

SMARTSHARE

The bears on Dalal Street have been sent into premature hibernation. Bulls are stampeding all over the place. The indices are doing an Indian rope trick. Stock prices are racing to the moon. And yet, investors are scared.

Stocks rise on improving fundamentals and also if they happen to be chased by liquidity. It is abundantly clear, even to the newest entrant to the markets, that the latter is the case.

The FIIs are pumping in money like there is no tomorrow. In the month of October, in the nine trading sessions that we have had till Thursday, around Rs 13,051 crore has come in. In the last month, close to Rs 18,948 crore had been pumped in by the FIIs.

Put together, that works out to Rs 31,999 crore in a matter of six weeks. To put things in perspective, in none of the years from 1993 to 2003 had so much money come in during even a single year, not to talk of six weeks. Last year, for the full calendar year, Rs 36,198 crore had been brought in by the FIIs.

No wonder, therefore, that the Sensex has risen more than 5,000 points from the August low of 13,779, a rise of 36.47 per cent. This sort of urgency is usually seen at market tops. In the buildup to the year 2000 peak of 6,150, the Sensex had risen around 34 per cent in the preceding two months, a score which is equal to the recent surge of the Sensex.

But if you look at the 1992 Harshad Mehta rally, it was made of sterner stuff. In the previous two months before the peak was attained, the Sensex had risen 101 per cent.

Why is so much money coming to India? The Indian economy is among the fastest growing in the world, the Indian population dynamics are very interesting and the consumption story is just beginning.

And Indian currency is on an upward spiral that any foreign investor would relish. But it has been this way for the past four years. Why the sudden realisation now?

Where is this money coming from? Who are these new investors? How much of this is through the participatory note (PN) route? Is the political money returning home before the elections or are the industrialists bringing home the booty that was stashed abroad by over-invoicing during the license raj? Unfortunately, all this information is not in the public domain and even the regulators may not have a complete hang of things.

We go back to our theory of the three-legged stool of the Indian capital markets, where the first leg is the appreciating rupee, where it is no more lucrative to hold the money abroad in dollars.

The second leg is the PN or participatory note, where money can come in to the capital markets under disguise, and the third leg of course is the capital gains exemption if stocks are held for over a year. As long as the three legs of the stool are intact, the rally can continue.

If this money was real FII money, the growth of the market would have been more broad-based and not so narrow "" that is for anyone with two eyes and some common sense to see.

My guess, though I may be wrong, is that a lot of the money coming through the PN route is being used to mop up stocks beyond what the creeping acquisition route would allow. Those entities can always sell the shares back to the promoters at a later date. The same could come in handy if tomorrow the stocks need to be placed at a higher price.

Going by the guestimates of how much money Indians have stashed abroad over the years, it is only the tail of the elephant that has come in. Therefore, it may be premature to call this a top. Draupadi's proverbial saree may have an end, but this money from abroad may not.

The near-vertical rise in the stock prices and the FII inflows taken together indicate that the days of the unencumbered use of PNs may be numbered. That is the only thing that may explain this anxiety to bring home the booty before the shutters are pulled down.