More than 15% annually – this has been the average growth of India’s stock market since the acronym BRIC came into existence in 2001. It seems that this is only the beginning. When EY conducted a survey of last year’s Davos participants on the most promising stock market in the coming years, more than 30% of respondents placed India first, and in 60% of cases, it was placed in the top three choices. The runner-up, China, has been identified as the best option by only 16% of participants. The following article discusses how one of the largest stock markets in the world works.
Although equity exchanges appeared in India earlier than anywhere else in Asia, the real establishment of the local stock market came about with the reforms of 1991, when the government of Narasimha Rao turned away from the planned economy and started its liberalization. Over the past 25 years, several governments, led by different political parties and coalitions, ruled the country, but none of them questioned the necessity and irreversibility of the liberal reforms in the economy.
As a result, the country experienced a twofold to threefold increase in growth and the emergence of multi-million middle class, which now ranks among the country’s and region’s main consumers. Then, in 2001, Goldman Sachs coined the term BRIC, and in 2015, India received the status of the fastest large growing economy in the world, overtaking China.
The stock market has been an invaluable support to such growth of the economy. The extent of the market development can be best proxied by its size – a very simple, but significant measure. Prior to the reforms, the total capitalization of all listed companies amounted to only 12-15% of the country’s GDP, which was three to four times lower than the average global values (with the lag from more developed markets being even greater). Today, 25 years later, India is among the top 10 countries by market capitalization, and its ratio to GDP has reached 80-90%, similar to the levels of the most developed countries.
A RECORD NUMBER OF LISTED COMPANIES
India ranks first in the world in terms of number of companies listed on its stock exchanges. The Bombay Stock Exchange – Asia’s oldest stock exchange, founded in 1855 – today has more than 5,900 firms. Only at the peak of the Internet boom in 2000 did the US have more quoted companies – about 7,000. Today, America is in second place with just under 4,400 firms. Countries like Japan, the UK, Canada, and China are also in the top 10 with more than 2,800 companies. The other BRICS members do not stand out with such a variety of market participants – in Russia, Brazil, and South Africa between 250 and 350 companies are listed.
Stock exchanges and investors
Seven stock exchanges currently exist in India, including BSE (Bombay Stock Exchange) and NSE (National Stock Exchange). Just four years ago, there were 24 stock exchanges in the country, but most of them decided to use the option of voluntary license refusal, proposed by SEBI (Securities and Exchange Board of India) in 2012. NSE, launched only in 1994, was able to accumulate more than two-thirds of the overall trading turnover. Creation from scratch has allowed it to very quickly become one of the most technologically advanced stock exchanges in Asia, applying most innovative and developed tools and instruments. Interesting enough, the futures on the largest Indian Nifty-50 companies, created and traded on the NSE, became the most traded futures contract in the world in 2016.
While market infrastructure is continuously consolidating, its investor base is, on the contrary, expanding and broadening. The market penetration is increasing considerably – today, over 46 million accounts are opened by private investors in India. Especially, after Narendra Modi’s win of the elections in 2014, professional market participants, both local and international, have intensified their activities – last year alone, the number of funds registered with SEBI, increased by more than half.
Nevertheless, investment funds registered in India own less than seven percent of the stock market in the country. The largest shareholders of Indian companies are their founders (promoters) and foreign investors.
The controlling investor
Fifty-one percent of the total market capitalization of the 500 largest Indian companies is in the hands of so-called promoters. Usually, these are family-founders of the companies, sometimes in the third or fourth generation, their relatives, and other affiliates. In addition, this category includes the state, which accounts for about a fifth of all promoters’ shares.
Typically, promoters hold key management positions in companies, often in charge of the business’ operational management. Since a developed corporate bond market is lacking in the country, promoters actively use the practice of pledging their shares to local banks for getting loans. Up to 13% of total promoters’ shares are currently pledged across the market.
In some well-known companies, the share of promoters reaches 60% or more, for example, at such market leaders like Wipro, Tata Consultancy, and DLF with 72-74%. With a set statutory boundary for promoters at 75%, it is obvious that the founders of these companies have left the maximum allowed stakes in their own hands. Indeed, even the most public companies are often only seemingly public.
This specific shareholding pattern lays emphasis on other aspects. For example, the impossibility of adequate separation of ownership and management relations. There may be problems with inheritance within promoters’ families, and professional managers are likely to find it difficult to fit into the hierarchical governance structure of a family business.
Foreign investors should pay more attention to doing adequate research on promoters when investing into Indian companies. Their reputation, ownership proportions, specialization, and even the history of family relations can all have a significant impact on the equity price dynamics of companies in which the promoters not only own 50% or more, but also take all important operational decisions.
'1 TRILLION CLUB'
The two major Indian stock exchanges - BSE and NSE - are part of the so-called ‘$1 Trillion Club’, consisting of 16 major world stock exchanges, each of which list shares of companies with an aggregate market capitalization of over $1 trillion. These 16 stock exchanges account for over 85% of the global market. Of the BRICS countries, apart from India, China also has two exchanges with market capitalization of more than $1 trillion each - in Shanghai and Shenzhen. Worldwide, most of such exchanges lie in the Asian region - two in India and China, as well as one each in Hong Kong, Japan, and South Korea.
portfolio investors own about 20% of the Indian stock market and are
second only to promoters. Since promoters do not trade their positions
as actively as other shareholders, foreign investors become major
players in the market with the highest contribution to trading volume
Currently, the number of foreign investors in India has exceeded 8,000, with more than a third of them registered in the United States. The United States is the largest foreign investor in India, with more than $100 billion invested in the local stock market.
Foreign investors are often criticized for being too opportunistic and speculative with their investments. Indeed, they do only seven to eight percent of their transactions in the cash segment, while the rest of the capital goes into the derivatives segment, which by definition is more short-term-oriented and speculative. However, a similar ratio is observed in the entire market: Options and futures turnover on the Indian stock exchanges is 12-13 times higher than the turnover of the shares themselves. Thus, there is hardly any reason to put all the blame for the high market volatility onto foreign investors.
The biggest foreign investor is the American Europacific Growth Fund, managing approximately $125 billion worldwide, of which 99% is invested outside the United States. About eight percent of the fund’s capital is placed with Indian companies – this is the maximum proportion among all emerging markets in the fund, second only to Japan and the UK. Fund managers called the country’s favorable demographics the main reason for this overweighing.
The same factor is key to the fund’s portfolio concentration in the financial sector, which should become one of the main beneficiaries of the country’s growing middle class. Indian HDFC Bank is in second position in the fund’s overall portfolio, ahead of such global giants as Novartis, Alibaba, and Nintendo. By the way, HDFC Bank and the financial sector as a whole are traditionally popular with foreign investors in India.
According to various estimates, only three to four percent of the Indian population has put their savings into equities. This is not surprising, considering the fact, that many Indians still have no access to the financial system, not to mention lack the resources to invest. Also in monetary terms, the share of equity investments in the overall distribution of household assets is negligible – less than three percent, which is much lower than in developed countries (the US – 42%, Europe – 30%), and BRICS partners (South Africa – 23%, China – 17%).
Attracting a larger number of private investors is vital for any market, but in the case of India, it is even more important. Their capital can contribute significantly to the overall stability of the stock market. In contrast to foreign investors, private investors have 25% or more put into the cash segment, and this is mainly long-term money, which does not leave the market with the first correction movements.
Since autumn 2015, Indian regulator SEBI has been working on a unique innovation, showing remarkable creativity in this regard. According to its plans, private investors will soon be able to buy mutual funds through the largest e-commerce platforms: Amazon, Flipkart, and others. Of course, there are many open issues and limitations here, such as the definition of the customer’s risk profile, commission charge, the secondary market, the maximum investment sum, and others. But the mere step in this direction shows a high degree of state readiness to take all possible measures to develop the market, improve its efficiency and transparency, and to attract additional capital.
The Indian stock market has every reason to become one of the headliners for international investors in the coming years. On the one hand, the country has successfully received the status of the fastest-growing of the world’s major economies, and is not going to part with it. This positively affects companies’ profits and, accordingly, the profitability of investments into their shares.
On the other hand, the participation of private investors will continue to grow through the process of deeper penetration of banking services, mobile communications, and the Internet, as well through the population’s income growth, which will give the market and the whole economy additional support.
The proactive regulator’s position plays an important role and deals with market cleansing, making it more efficient, transparent, and open for innovations. Also, the business community creates more favorable conditions for investors. In recent years, major Indian companies have been able to successfully implement international standards of accounting, transparency, and anti-corruption programs. Transparency International’s last rating, composed of the 100 largest companies in developing countries, was led exclusively Indian representatives; Bharti Airtel, Tata Communications, Mahindra & Mahindra, and 12 of the top 25 companies were from India.
Sure, the stock market is not a one-way street, and any market experiences correction phases from time to time, often quite sharp and painful. In this regard, it is worth mentioning a statement from the world’s most renowned investor, Warren Buffett: “Unless you can watch your stock holding decline by 50 percent without becoming panic-stricken, you should not be in the stock market.” The Indian market will open up remarkable opportunities for achieving high results in the coming years to investors with such strong character.