Promoters and other large shareholders in a particular company can also indulge in such transactions. No one gets hurt in circular trading, until some events lead to a panic of sorts, leaving the retail investors with shares whose prices have crashed. In some cases, it's akin to insider trading. Mid- and small cap companies are particularly prone to it, especially where the promoters' holdings are huge and there's little liquid stock in the open market. It works even better when it comes to the so-called penny stocks, which normally languish at low prices (mostly below their face value), are not traded for months, but suddenly rise in a bullish market. The increase in scrip prices of these firms is not backed by their financials.
Outlook's research discovered 200 such stocks, whose prices had at least doubled in the past six months. Some of them had shown whopping increases of a few hundred times (see table). While all of them might not be being manipulated, there's a case that there might be something wrong with some of these stocks. This explains why the finance ministry has openly said that 40-50 penny stocks are under SEBI's radar. It also explains why the mid- and small-cap scrips were among the worst hit last week.
On Wednesday, when the Sensex and Nifty recovered most of their intra-day losses, the Nifty Junior (small-cap) and the CNX Midcap Indices were down 96 and 87 points, respectively. The next day, while the Sensex was down 3 per cent, the BSE small-cap Index lost 7.62 per cent and the BSE Mid-cap Index 5.6 per cent. There were obvious fears that irregularities were more likely to be found in the mid- and the small-cap stocks and everyone wanted to get out them. Experts like Kirit Somaiya of the Investor Grievances Forum have questioned the laxity shown by SEBI in investigating such scrips.
Another area of concern for the regulators pertains to FIIs dealings through, what's called the participatory notes (PN). In simple terms, PNs are derivatives contracts issued by the FIIs to either individuals or corporates, who are based in the FIIs' respective countries and wish to invest in the Indian markets without being identified. The notes enable FIIs to invest the money in Indian equities. As experience has shown, PNs are prone to irregularities, and the Indian regulators were unable to know the real source of inflows through this route and to figure out if the money was tainted.
In November 2003, for example, SEBI disclosed that 26 per cent of the net FIIs' investments (of Rs 90,000 crore) was throughPNs.Investigations found that several overseas corporate bodies (OCBs) that had such deals with the FIIs had Indian-sounding names like Ram Trading, Wadhwani Asset Management, Indea Capital and Indus Holdings. Although it could never be proved, the thinking was that money was being channelised out of the country, and flowing back into the Indian markets through the PN route. This was a major reason why SEBI banned OCBs from participating in Indian equities and also stated that PNs could only be issued by the FIIs to investors who were being regulated in their respective countries.
However, the PN fears have come to haunt the Indian bourses again. Recent estimates show that nearly 40 per cent of the FII inflows is through PNs. Yet again, the Indian regulators have no idea about the origins of the money. The same is the case with a few recent examples, where money has come through the Mauritius route to be invested in Indian equities. The investigating authorities feel that this could be a way to channelise the black money generated in India or abroad into the stockmarkets.
Despite such grey areas, many analysts feel the so-called scam elements are minimal, and term the events on Wednesday and Thursday as a "much-needed correction." They contend that since the Sensex had zoomed 1500 points since June, some wobbliness at such high levels would be surprising only if it didn't happen. "Everything that has happened in the markets over the past few months had been unprecedented, and the reality check is welcome," says one of them. Adds R. Rajagopal, VP (equity investments),IDBI Capital Market Services, "The FIIs have invested over $3 billion in the last few months, which is as much as what they would invest in an entire year earlier. The market also needs some breathing space."
Already, the Sensex is up 49 per cent in this calendar year. It now offers the second-highest returns, after the Korean Index. Inflows by both the FIIs and the domestic institutions remain strong. Therefore, a few speed breakers in this bull run is only an indication that the markets are functioning smoothly, efficiently and in a mature manner. "All bull runs witness corrections at regular intervals. There's no need to panic at every drop of a few hundred points," explains a Delhi-based broker.
What's important is that the FIIs still seem interested in the India story. According to emergingportfolio.com, India has received 50-65 per cent of FIIs' inflows into Asia since March this year. "India has been the runaway winner," says Cameron Brandt, international markets editor of emergingportfolio.com. He feel that despite high valuations—one fund manager termed India as the Armani or Hugo Boss among emerging markets—there's still some steam in India. "Valuations are not excessive. But they are getting richer, especially for the small universe of top-tier stocks that are well known to the foreign money managers. If you look at the bigger pool of listed Indian stocks, many are lightly valued because a lack of information about them implies there's no foreign interest," he explains.
A renewed FIIs' interest will impact the markets positively. "We are seeing a rerating of the market because of higher FIIs' interest. This is something we have never seen before. So, we feel there's something wrong with it," says Anup Maheshwari, senior VP, DSP Merrll Lynch. He adds that while the FIIs control about 25 per cent of all stocks in most Asian markets, the figure is 21 per cent in India. So, there's still space for the foreigners to increase their holdings and pump in fresh money.
Will last week's events turn out to be an aberration? If it does turn out that way, a major reason will be the ever-changing attitude of the policymakers and theregulators.Just days after hinting that they would not spare manipulators and speculators, both the finance ministry and SEBI did an almost about-turn. By Thursday evening, the ministry stated that it hadn't yet found any evidence of manipualtions. SEBI said that it, too, had found nothing wrong with the markets. ThePMO denied reports that it had held any meeting to discuss the irregularities in the current bull run.
It was clear that the jittery Sensex was forcing a rethink amongst various government institutions. None of them wanted to rock the markets; they only wanted to issue a warning to the major players and to the small investors. As one market player observed, "They were only trying to be proactive so that they are not caught napping in case there's indeed a scam." If there isn't any, the bull run may continue. The only obstacle will be in the form of less-than-expected corporate results in the second quarter. "Valuations have already been factored in high corporate growth and any failure to meet expectations will lead to disappointments," feels IL&FS' Nadkarni.
Others add that the Indian market has moved ahead of itself and, therefore, the phase of volatility and correction is likely to continue. Traditionally, the beginning of the festive season signals the beginning of a new bullish phase. But, as Maheshwari concludes: "This is not a traditional year."
