Efficient capital market may kickstart investment cycle in India


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An innovative initiative proposed in the Union Budget 2019-20 relates to the minimum public shareholding (MPS) of listed companies, which would increase from the current level of 25% to 35%, going forward. The time frame for the same is not specified. Going by past experience, India took about eight years to achieve 25% MPS in listed companies, and many PSUs are yet to reach the stipulated MPS. Hence, raising it to 35% may take at least five years from now, unless the government, in consultation with SEBI, issues a whip to achieve it as early as possible.

After the global financial crisis, both Dow Jones Industrial Average and BSE Sensexwere hovering at 8,000-9,000 points (December 2008). While the former crossed 27,000 by early July 2019, BSE Sensex surpassed the 40,000 mark before the Budget. It would be unwise to believe that India’s macroeconomic fundamentals are more stable than those of the US in the medium term. India’s capital markets story points towards excessive speculative activities. This has been possible mainly due to too much money chasing too few floating stocks. Widening of MPS, proposed in the last Budget, is therefore considered a decision in the right direction.

This initiative would not only curb excessive speculative activities, but also channelise household savings towards capital markets in a big way. Moreover, volatility in the Indian stock market may decline due to availability of large floating stocks. When the government is committed to widen the floating stocks, there is little scope for large buybacks of equities. In this context, the government’s decision to tax buybacks of shares of a listed company at 20%, similar to those of unlisted companies, is a welcome step. The pressure of the corporate sector to waive tax on buybacks of equity shares of listed company, if entertained, may defeat the vary purpose of widening MPS.

As of now, many corporate houses are deleveraging to resolve their balance sheet problem. In fact, they are not in a position to honour their commitments on loan repayments/servicing of debt securities. How can they finance buyback of equities in such a situation? Would it create artificial scarcity of floating stocks and jack up equity prices, leading to speculative bubble? So, buybacks of equity shares of listed companies should not be encouraged, let alone waiving of tax on buybacks.

Price discovery may be efficient if equities are widely held, instead of in the hands of a few stakeholders. Moreover, concentration of shares in the hands of a few encourages governance malpractices, including insider trading, which is rampant in India despite stringent SEBI regulations.

India’s equity markets reacted adversely in response to Budget proposals, despite positives like withdrawal of 24% limit on FPIs, merger of NRI investment with FPIs within sectoral limits, development of secondary market in AAA-rated corporate bonds, social stock exchange, etc. Besides hike in MPS, FIIs investing in India as trusts/association of persons were affected due to hike in surcharge on the super-rich—annual income of individual/trust exceeding `2 crore.

Currently, about 40% of FIIs are operating as trusts in India. Since FIIs have the option to convert into corporate entities to avoid payment of surcharges, income tax laws need not be revised for them. The government may have to take a call on one-time transfer of shares from trust to corporate floated by FIIs. This will clean up non-transparent and unhealthy practices followed by FIIs to access India’s capital markets. Immediate reactions of India’s equity markets to Budget proposals need to be seen in the context of speculative positions that might have built up after the landslide victory of the incumbent government in the elections.

Given the twin balance sheet problem, sluggish growth in private investment and poor performance of export sector due to global headwinds, correction of India’s capital markets closer to medium-term fundamentals may be treated as a healthy sign—from the point of view of medium-term consolidation of capital markets. Moreover, price discovery based on fundamentals of the economy can encourage fresh equity investments and revive animal spirits amongst entrepreneurs. An efficient capital market may, therefore, kick-start the much-needed virtuous investment cycle in India.

(The author is visiting fellow, IGIDR, and former Principal Adviser of the Monetary Policy Department of RBI. Views are personal.)


Written by Loknath Das