Despite the stubborn refusal of the BSE Sensex to close above the psychological barrier of 6,000 on the muhurat of Samvat 2061, the Indian market is clearly set for a continued flow of large portfolio investment by Foreign Institutional Investors (FIIs) in the coming months.
FII investment this year has already touched $6 billion, with half of it invested in Initial Public Offerings (IPOs) of Indian companies. That is only the beginning. Many giant funds have only just tested Indian waters and are desperately seeking new investment avenues and fresh equity offerings by existing blue chip companies.
Typically also, foreign investors have begun to use their considerable clout to complain about the lack of liquidity in Indian markets in order to try and force open new sectors, or to dilute existing rules and restrictions to be able to access large blocks of good company shares without any restrictions on their exit. They would also like to see more Indian institutional investors coming into the market to share the risk. Specifically, they would like to see Indian pension funds being invested in equity.
FIIs are also eyeing the Indian commodity futures market, which has seen turnover galloping in the last few months. Interestingly, FII entry into this market seems to have had the blessings of the Forward Markets Commission (FMC) for a long time now. In July 2001, FMC first wrote to Sebi about allowing foreign investors into commodity markets. It had then argued that the markets needed institutional investors to strengthen them.
In 2004, FIIs are keener than ever to get a piece of the action in the bullion and food grain futures markets. Media reports suggest that the government is already formulating a policy framework to allow FIIs, banks and mutual funds into this sector. FII entry into commodity trading seems inevitable, but unless there is a strong regulatory system in place, it is a sure way of endangering the nascent market.
Last week, the Union Cabinet cleared the proposal to set up a separate Pension Regulator rather than have the pension business regulated by the Insurance Regulatory and Development Authority. In case of commodity futures, however, the government has decided that the products are similar to financial derivatives and are best regulated by the Sebi. Curiously enough, regulation of the commodity futures markets is being framed after the markets are showing dangerous signs of manipulation.
While it is one thing to have a political consensus on Sebi as the regulator, there has to be a lot more action on the ground before the government even considers opening it up to foreign investors. Sebi has to be formally put in charge of the market; its staff strength must be considerably enhanced with a full-time board member overseeing the new responsibility. Some basic rules such as annual inspection of bourses and annual inspections for brokers need to be formalised and regulation covering price manipulation and insider trading must be re-worked and made applicable to this market.
The same goes for Pension Funds. The opening up of the market to new, contributory pension funds is whole new arena that is fraught with many dangers. After the split of Unit Trust of India following the double debacles of 1998 and 2000, this will be the biggest pool of funds that will be the target of every unscrupulous market operator and businessman colluding with friendly politicians.
The first signal of the Congress-led government’s seriousness about running a clean and scam-free pension fund industry will be in the appointment of the first chairman of the Pension Fund Development and Regulatory Authority. New, contributory pension fund schemes, may allow investors to opt for high risk-high reward schemes that invest in the equity market. However, the lacklustre record of the mutual fund industry suggests that people are not going to rush to subscribe to professionally-managed pools of money, unless they build a track record.
A recent, nation-wide investor survey (yet to be released to the public) shows that while investor interest in the equity markets has begun to revive after a decade, the same is not true of mutual funds. In fact, investor sentiment remains distinctly negative about mutual funds. The perception is that fund managers front run investments, burden retail investors with entry and exit loads and have yet to demonstrate spectacular performance on a steady basis.
The same will apply to pension funds, leading to the now familiar lobbying to allow them to operate with minimal regulation and to hype up their potential performance.
One would do well to recall that in 1991-92, a Congress-led government (with Dr Manmohan Singh and Dr Montek Singh Ahluwalia in charge) blundered on several fronts in the hurry to usher in financial sector reforms.
• Despite many warnings, it scrapped Capital Issue Control without transferring crucial regulatory powers to the Sebi. We are still grappling with the aftermath in the form of over Rs 10,000 crore lost to ‘vanishing companies’.
• It allowed bank mutual funds to come in with minimal regulation, ‘assured returns’ and dangerously hyped-up advertising claims. The poor performance of these funds is one of the biggest reasons why the mutual fund industry has remained stunted from the start.
• It refused to put Unit Trust of India under Sebi regulation, despite many Sebi recommendations. This eventually led to the double debacle that has severely damaged investor confidence and their trust in government.
• It allowed the listing of the shares of public sector enterprise, without following proper listing and disclosure norms. Even today, the level of transparency among PSU entities is less than applicable to other companies.
It is useful for investors to look closely at the decision makers in government today. Many of those responsible for some of those decisions are back at the helm today. And they are just as likely to get carried away by the pressure of foreign investment interest in India, to open up markets without putting in place appropriate checks and balances.