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If ever there was any doubt about the stranglehold that foreign institutional investors (FIIs) have on the Indian stock market, here’s the proof. Net sales of just Rs 60,000 crore by FIIs was enough to spark off a precipitous 60 per cent fall in the Sensex and a Rs 50 lakh crore erosion in the market cap between January 2008 and March 2009. The importance of foreign money in funding Indian businesses cannot be overemphasised. However, the whimsical nature of global liquidity flows and the fact that a sizeable proportion of the inflows are via participatory notes, makes such dependence tricky. So what are the options that policymakers have to loosen the FII grip?

The reason why Indian markets are exposed to such high impact costs from FII transactions is that no other category of investors is as yet large enough to provide a counter to FII activity. In terms of size, both domestic mutual funds and insurance companies, holding less than 5 per cent each of the outstanding equity, are dwarfed by FIIs who own close to 15 per cent. Nor do these domestic institutions have much freedom on the timing of their purchases or sales. With retail investors shying away from equity funds during market lows and frenetically chasing returns at every peak, domestic institutions are forced to shadow FIIs in their actions. It is up to the domestic institutions to bring about a change in the investor mindset from their futile attempts at ‘timing’ the markets, into taking a long-term view of equity investments. Investors should be encouraged to regularly put in a small portion of their monthly investments into equity products, without unduly worrying about market levels. Popularising the New Pension Scheme, which seeks to harvest individual savings for the retirement years could be a good beginning. Investing long term in stocks and greater institutionalisation of the stock market can also be incentivised through the tax regime. Stretching the definition of ‘long-term’ capital gains beyond a year and a favourable tax status for equity investments routed through institutions may help.

Indian households have only a minor exposure to the stock market. And it is not as if retail investors are totally averse to the stock market — on any given day, the volumes drummed up by retail investors punting on the bourses easily match FII activity. Channelling even a fraction of the Rs 40 lakh crore of household savings lying in bank deposits into the stock market will serve a dual purpose. It will arm domestic institutions with sufficient firepower to take an independent view of stocks. And it will allow retail investors too to earn inflation-beating returns to fund their retirement and other long term goals, in a scenario where guaranteed-return options are shrinking.

More Stories on : Editorial | Foreign Institutional Investors | Stock Markets

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