The Hindu Business Line : A new form of colonialism

Holding as much as 30 per cent of the equity capital of the 10 largest Indian companies, and nearly 20 per cent of the equity of the top 50 firms, foreign institutional investors are today responsible for determining the mood of the stock market. While SEBI suspects that a fifth of the funds brought in by FIIs could be "hot" money, it cannot easily establish this, let alone nail those guilty of such transactions, says Paranjoy Guha Thakurta.

FOREIGN investors are dominating India's stock market like never before. It is not exactly fashionable to say it, but the fact of the matter is that foreign institutional investors are today entirely responsible for determining the mood that prevails in the stock market. Nobody else apparently matters.

Forget the small investor. Even those who run mutual funds, heads of large financial institutions or even many captains of the corporate sector seem to be watching from the sidelines as FIIs determine the sentiments that dominate the bourses.

A number of studies have shown that what is currently taking place in India's stock exchanges is being determined by the purchase and sale decisions of the FIIs which, more often than not, tend to act as a "herd".

These studies have shown that there is "significant correlation" between net inflows of funds through FIIs and the movement of such major indices as the 30-share sensitive index of the Bombay Stock Exchange or the National Stock Exchange's Nifty.

If one plots the net inflows of FIIs on a graph, its shape would closely resemble the pattern of a chart depicting the movements of the Sensex or the Nifty.

At present, 500-plus FIIs operate over 1,300 sub-accounts in the country's stock exchanges. An FII is an institution established or incorporated outside India that invests in securities in this country. A sub-account could include foreign corporate entities, institutions, individuals, funds or portfolios established outside the country (whether incorporated or not) on whose behalf investments are made by an FII.

While FIIs have been allowed to invest in Indian securities from September 1992 onwards, the regulations governing the activities of FIIs were notified by the Securities and Exchange Board of India more than three years later, in November 1995.

The current bull run as well as boom phases in the recent past have been largely fuelled by the FIIs. Net cumulative investments by all the FIIs put together have crossed the figure of $20 billion (around Rs 1,00,000 crore, or one-twentieth of the country's gross domestic product).

Till the end of April 2001, net cumulative investments by all FIIs were lower by less than a quarter of the amount at present, or below $14 billion. In the current calendar year, the FIIs have pumped in more than $5 billion into the Indian stock market, including $1.4 billion in October alone.

As a block, FIIs reportedly hold as much as 30 per cent of the equity capital of the 10 largest Indian companies at present, and nearly 20 per cent of the equity of the top 50 companies. Domestic financial institutions, such as the Unit Trust of India, which used to be the mover and shaker of the stock market not very long ago, are today playing a subservient role on the bourses.

Why are the FIIs so keen on investing in India? At one level, there is a simple explanation. With India's real rate of growth of GDP expected to touch 7 per cent this financial year, it could perhaps be the fastest growing country in the world after China. It would thus be logical for foreign investors to look towards India as a lucrative place to park their money. But there is more to it than meets the eye.

The shares of close to 10,000 companies are listed on the two dozen stock exchanges in the country, all but a few of which are virtually defunct. On any given working day, between one million and two million transactions take place, utilising the services of more than 10,000 registered brokers and sub-brokers. At present, there are online trading terminals in more than 450 cities and small towns scattered across the length and breadth of India. Despite this impressive network, the fact remains that most small investors lack confidence in the ways of the stock market.

Many have burnt their fingers in scams and have found the value of their investments suddenly and sharply eroded. Under the circumstances, given the passive role played by small investors, it is not surprising that the FIIs are calling the shots.

According to SEBI, around one-fifth of the funds brought in by the FIIs could be "hot", if not illegal, money belonging to Indians who are bringing it back to the country following the strengthening of the rupee vis-à-vis the US dollar.

Such funds are recycled either through the deployment of participatory notes (PNs) that conceal the identity of the real holder of the funds, or through overseas corporate bodies (OCBs) controlled by non-resident Indians. Right now, SEBI is making strenuous efforts to find out the origins of the money invested in equity shares by the FIIs. It is common knowledge that certain company promoters have become adept at manipulating scrip prices with the help of particular FIIs.

Some of this manipulation takes place through OCBs, which are currently banned from participating in Indian equity market. The rigging is often done through offshore derivative instruments.

The December 2002 report of the Joint Parliamentary Committee on the securities scam mentions SEBI's "suspicion" that certain Indian promoters had purchased shares in their own companies through PNs issued by the FIIs. "This mechanism enables the holders to hide their identities and enables them to transact in the Indian capital market," the report stated.

In October 2001, SEBI had issued a circular to all the FIIs, asking them to disclose details of the PNs issued by them. The JPC had urged that if the FIIs did not disclose the information on the PNs issued by them, "stringent punitive action" should be taken against them.

SEBI had also told the JPC that more than 80 per cent of the OCBs are registered in the tax haven of Mauritius and some of these bodies seemed to be acting as a "front" for promoters of particular Indian companies.

The FIIs evidently ignored SEBI's instructions — that is, till August 28 this year, when the market regulator eventually decided to amend the regulations pertaining to FII operations and made it mandatory for the FIIs to disclose in a prescribed format every fortnight details of all offshore instruments issued by them against underlying Indian securities.

According to media reports, SEBI has also initiated adjudication proceedings and/or sought information from a number of FIIs associated with prominent international bodies, including Citigroup, JP Morgan Chase, HSBC and Goldman Sachs. Still, it is clear that it will not be easy for SEBI to lift the "corporate veil" and obtain the kind of information it is seeking from FIIs.

The Indian regulator does not have jurisdiction over the issuance of instruments like PNs outside the country. Even if SEBI manages to obtain information to the effect that the money used in the stock market has been illegally obtained, it would not be easy for it to nail those guilty of such transactions. SEBI has found that there are many layers of investors involved in these PNs, and most FIIs are reluctant to disclose information about the eventual beneficiaries of these instruments. All FIIs claim they wish to protect client confidentiality.

Of the total net investments made by all FIIs till the middle of October, an amount of over Rs 80,000 crore, as much as one-fifth, or more than Rs 15,000 crore, were made using PNs.

There is one difference in the new form of colonialism currently prevailing in India's stock market. Earlier, the colonial masters created a class of Indians to act according to their bidding. This time round, certain FIIs are now working in close concert with (and on behalf of) Indian collaborators — resident and non-resident — some of whose intentions are less than honourable.

(The author is Director, School of Convergence, International Management Institute, New Delhi. He can be contacted at paranjoy@yahoo.com.)

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