Signals from IPOs

Yesterday's performance of Reliance Power's stock, which, only a few weeks ago had astounded observers with the magnitude of oversubscription, must not be seen as just a reflection of the state of the share market. There are negative signals in this pattern for the state of the economy as well. As it happens, the performance of the stock on listing was not entirely unexpected. Last week, two major public offerings, those of Wockhardt and Emaar-MGF, were withdrawn because the market clearly had no appetite. This, of course, was a dramatic turnaround from the way in which the Reliance offering had been lapped up a short while ago. But, developments over the past few weeks have underscored the fact that market sentiment can turn in an instant and no stock and, for that matter, no country is immune from a change in investor sentiment. Given the persistence of market volatility, the IPO bloodbath is unlikely to end very soon, putting many, if not all, the issues in the pipeline back on the shelf. As investors, particularly in the retail segment, come to terms with the end of the great surge, they will be reluctant to re-enter the market even when it shows signs of stabilizing. The bottom line is that, for some time to come, companies will find it difficult and more expensive to raise money from the stock market to finance their expansion plans.

This is where the link with economic performance comes in. The growth surge seen over the past four years has been significantly contributed to by an increase in investment activity across the board, but particularly in the manufacturing sector. Fixed investment as a ratio to GDP crossed the 30 per cent mark for the first time during this period, largely because of a sharp increase in private sector investment. As perceptions about the sustainability of this growth momentum became more widespread, more and more businesses invested in expansion. Thus was put into motion a virtuous investment-growth cycle. Of course, it could not have been expected to last forever; sooner or later, businesses would have decided that their capacity was adequate to support even optimistic growth projections. However, the way that the market has begun treating public offerings and newly listed stocks suggests that the investment cycle will be brought to an abrupt end by emerging financial constraints. Of course, companies can always fall back on internal resources to finance growth, but the reality is that, over the past couple of quarters, profit margins in several sectors have been flat. Most companies still have substantial free cash (reflected in the large share of "other income" in their quarterly profit numbers), but fresh accretions have slowed down, and the drawdown to finance committed expansion plans will now begin to show.

It must be emphasised though that this is a pattern characteristic of a business cycle and in no way vitiates the significance of the economy's underlying growth drivers. Global factors are obviously important contributors to these patterns but, over recent months, it appears that domestic growth drivers are also showing signs of flagging. Both sets of factors will eventually turn around, as a combination of policy stimuli and self-correcting market forces takes effect. Until then, investors and businesses will be well advised to shift their attention from the euphoria of the past couple of years to more objective and realistic assessments of business strategies and value propositions. Downturns also offer opportunities to the careful and informed investor.