Since ancient times stories are considered to be the best and easiest way of teaching. Hence, stories are not only seen as a form of entertainment but also as a tool to teach management lessons. The stories of ‘Panchatantra’, ‘Ramayana’, ‘Mahabharata’ and ‘Vikram & Vetal’ not only entertained us but in the end also provided lessons in management. Hence, even I thought of telling a story on the stock market. Rather, there are a number of stories to be told about the Indian stock market. However, I feel this one seems to be more relevant from the Indian perspective. The story in a simple way explains how the operators work and the gullibility of the retail investors.

"Once upon a time in a village, a businessman appeared and asked the villagers, what do you do for living? They answered we are farmers and do farming. He said you must have an alternate source of earnings and suggested that since the village was surrounded by a deep forest, this would provide for an ideal earning opportunity for them. He announced to the villagers that if they got him monkeys from the forest, he would buy the animals for Rs 10 each.

The villagers, seeing that there were many monkeys around, went out to the forest and started catching them. Everyone in the village earned in thousands. However, this frenetic pace of hunting quickly diminished the number of monkeys in the forest and the villagers per force had to stop this activity.

Looking at the diminished supply, the businessman announced that he would now buy monkeys at Rs 20. This prompted the villagers to make a renewed effort and they now ventured still deeper into the forest to catch the beasts. Once again, however, the supply diminished and the villagers lost interest, returning to their farms for a living. But then the businessman increased the offer to Rs 25 each. This sparked off enthusiasm in the villagers yet again. However, the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!

The businessman now announced that he would buy monkeys at Rs 50! The offer lured each and every villager.  However, in between, the businessman had to go to the city on some business visit and his assistant started to look after the business on behalf of him.

In the meantime the villagers had befriended the assistant as they considered him one of them. In the absence of the businessman, the assistant told the villagers: “Look at all these monkeys in the big cage that the man has collected. I will sell them to you at Rs 35 and when the man returns from the city, you can sell them to him for Rs 50 each.”

The villagers rounded up all their savings and bought all the monkeys. But when they visited the businessman’s place, there was no sign of the businessman or the assistant. There were only monkeys everywhere!"

Now I guess you have a better understanding of how the operators work in the stock market. So beware of such things while investing in the market. The monkeys here signify the operator-based stock.

The question is how to identify such stock. The foremost factor is to analyse the volume pattern in the past one year. These kinds of stocks usually have an erratic volume pattern. If there is any discrepancy on the volume front, it is always better to avoid the stock. The second factor is that you should always make an attempt to understand the business of the company before investing in it. Here also I would suggest that investors should not judge a company by its name. I know of one company called IKF Technologies. Many assume it to be an IT software development company.  To everyone’s surprise, the company was into bio-fuel manufactured from jatropha seeds.

In the past, I have stated time and again that by asking a few questions to ourselves, we can avoid many a bad investments. So be cautious and avoid buying monkeys as stated in the story.

The percentage of the retail individual investors segment in the Indian capital market is insignificant. This may be attributed to the riskiness involved in the asset class, combined with a lack of financial literacy. An interesting survey by Max New York and the National Council For Applied Economic Research (NCAER) says that Indian household investors entrust an average of only 12% of their savings with financial products.

The government is trying to attract such investors by incentivising retail participation in India. The Union Budget 2012-2013 presented by the Finance Minister, Mr. Pranab Mukherjee, made a new attempt to improve the flow of funds into the domestic market by announcing the Rajiv Gandhi Equity Savings Scheme.

This scheme is applicable to new investors whose gross annual income is less than Rs 10 lakh. Under the scheme, they can avail themselves of a 50% deduction for a maximum investment of Rs 50000, with a lock-in period of 3 years. Hence, the maximum deduction available for one time to first-timers cannot exceed Rs 25000. The authorities were inspired by the precedent set in France, followed by Belgium and other European countries, where the introduction of similar schemes in the early 1970s helped in increasing the percentages of retail investors by approximately 10%.

The objective of bringing new funds into the market through the Rajiv Gandhi Equity Savings Scheme also comes with certain challenges. The scheme is designed to make new market entrants invest directly in the most risky asset class, which is very dynamic in the current scenario. Though investment in equity is not very complex, the task of identifying the right companies and maintaining the lock-in period for 3 years to avail the benefit is the key challenge.

The scheme has also paved the way for the insertion of the new Section 80 CCG. However, any default that arises after claiming the deduction will reconsider the deducted amount as taxable income in the year of default. The investor will get a maximum deduction of Rs 25000 for one time. The tax consideration may lure investors to enter the market for tax planning only during the last quarter.

Also, if investment through this scheme is restricted to the top 100 stocks by market capitalisation of the NSE and BSE, the other listed companies will miss the inflow of new funds. In addition, investors miss out on the benefits they can reap by investing in growth stocks. The top 100 stocks by market capitalisation, though fundamentally strong, are generally of high value, and do not guarantee profits always.

As stated before, new retail investors can avail themselves of the benefit under RGESS only once. However, the term ‘new retail investor’ is yet to be defined. If the opening of a demat account is the only consideration to identify a new retail investor, then there is a huge untapped market in India, considering the existing data base of 1.5 crore Permanent Account Number (PAN) holders with an annual gross income between Rs 2-10 lakh.

The scheme has been lauded by the brokerage industry, as it is expected to lead to an increase in demat and broking accounts by around 2 crore. However, it has received a thumbs down from the players due to the 3-year lock-in period, considering the current scenario of long-term investment tenure in equity as an asset class.

It must be said that a professionally managed approach may help first timers more than direct investing. However, the introduction of this scheme would certainly promote direct participation and increase equity culture in the Indian capital market. The scheme would be effective, successful and sustainable only if the government ensures protection to the investment.

Inflation is defined as a steady and sustained increase in the general price level. In India, the impact of inflation is reflected in the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). Among all the BRICS countries, or the emerging economies, the inflation rate in India is the highest at 9.5%, as compared to 7.2% in Brazil, 8.2% in Russia, 6.2% in China and 5.3% in South Africa.

Usually, inflation is associated with high levels of purchasing power and brisk industrial activity. This is because high inflation results in increased demand, which gives a boost to investment and production. Economists are of the opinion that a moderate level of inflation acts as a stimulus to the economy. However, beyond a certain threshold limit, inflation is no longer a stimulant but an impediment. This seems to be true for the Indian economy. The GDP growth rate has slumped to 6.1%, and the IIP has shrunk to a dismal 3.5% – even FICCI has stated that this rate has not bottomed out, and may fall further.

S&P has recently downgraded the Indian economy from BBB+ status to BBB-, with a warning of further downgrades if there is no improvement in the country’s fiscal and political environment. We seem to be just a step away from being reduced to junk bond status unless structural economic reforms are carried out. S&P has also lowered the credit rating of premier Indian commercial banks like SBI, ICICI Bank and HDFC Bank, and this does not augur well for our economy.

Both S&P and IMF are of the opinion that large-scale fiscal reforms are required to be executed to take India back onto the growth trajectory. The IMF has suggested that India needs to refocus on investment in infrastructure, fiscal consolidation, inflation control and further structural economic reforms if it has to sustain its growth momentum. The structural economic reforms include issues like the introduction of the Goods and Services Tax, capital account liberalization, and doing away with subsidies.

There ought to be a close inter-linkage between the RBI’s monetary policy and the Indian government’s fiscal policy. Presently, these two policies seem to be working at cross purposes. The country has a tight monetary policy, where the RBI has intervened 13 times in the past 12 months to bring order to the Indian economy. On the other hand, our fiscal policy is expansionary in nature, with demands ranging from subsidies to politically expedient expenditure. The government needs to control the fiscal deficit and control non-development and subsidy expenditure. The IMF has expressed that fiscal consolidation is the need of the hour for the Indian economy. It is not possible to contain inflation with a tight monetary policy but a profligate fiscal policy, as the gains in one are more than offset by the losses in the other.

Inflation in India has been empirically stated to be on account of constraints on the supply side. This means that increased demand in India is a reality that must be met with an equal supply side response of producing more goods and services. Investments in the economy must widen and funnel into new spheres that have created growth impulses. However, new investments cannot flourish in a scenario where there are high interest rates accompanied by political instability. Following an increase in demand, the supply of goods and services has not been able to respond in equal measure, resulting in shortages that are propelling the prices northwards.

India has a very favourable demographic profile in terms of age distribution, which puts a vast majority of the labour force in the productive bracket. However, enhancement of the skills and productivity levels of this labour force is critical to reap the benefits of this unique demographic profile. Else, this factor of great strength might turn out to be a liability of huge proportions. We have always been wary of the tagline “jobless growth”, but have not invested enough in human resources to tap this potential and make economic growth an inclusive process. Unless the skills dividend of the Indian labour force is optimised, the supply of goods and services cannot be increased to meet the enhanced demand.

Thus, high growth together with high inflation, as witnessed presently in India, is not sustainable. The onus is squarely on the government to ring in economic reforms and rationalise its expenditure. Economics must rule over political compulsions if India is to forge ahead as a true economic powerhouse.

 (Inflation Clouds Loom Ahead  http://www.dsij.in/Research/Blog/TabId/806/PostId/30/Inflation-Clouds-Loom-Ahead.aspx)