The gloom in the Indian capital markets

The current high levels of indices of Indian stock markets, Sensex and Nifty are deceptive. Sensex and Nifty are presently quoting near about 36,000 and 11,000 levels respectively, which are just 10% lower than their all-time highs.

These bellwether indices hide more than what they reveal about the current state of Indian stock markets and the economy. They have finished the calendar year 2018 with modest gains of 5.90% and 3.20% respectively, after a roller-coaster ride. What the main indices hide are major revelations about the distress prevailing in the financial markets, depressed investor sentiments, declining corporate profits and the headwinds facing the economy.

During the calendar year 2018, BSE Mid-cap and Small-cap indexes have seen their steepest fall of last seven years. They have posted negative returns of (-)14% and (-) 24% respectively for the year. Total market capitalisation of all listed firms on BSE has declined by 5% during the year from ₹151.7 trillion to ₹144.1 trillion. In other words, stock market wealth worth over ₹ 7.6 trillion was wiped out during calendar 2018, though the main indices are showing positive returns for the year. During the month of January of 2019, stock market wealth has further eroded by another ₹5 trillion to ₹139 trillion.

Even the investors in equity mutual funds were bruised during the year 2018. While large-cap equity funds gave meagre returns, small-cap funds posted big negative returns close to (-) 30%. Among the large cap open-ended equity funds, Axis Blue chip Fund emerged as the best performer of the year by delivering a modest 5.8% return. Small-cap equity funds are a sea of red. Marquee names like Sundaram Small Cap Fund, HSBC Small Cap Equity Fund etc have delivered negative returns of (-) 29% and (-) 26% respectively for the year.

Stock market experts attribute introduction of Long Term Capital Gains tax (LTCG) in last year’s budget and SEBI's reclassification of mutual funds as the prime reasons for the steep fall in mid-cap and small-cap indexes, though there are several other fundamental and structural reasons.

In 2004, UPA -1 government had introduced the simpler and transparent method of levying Securities Transaction Tax (STT) as a proxy for capital gains tax. While retaining the STT, the NDA government reintroduced LTGC tax in the union budget of 2018. Many stock market investors feel that this amounts to double taxation.

Due to grand-fathering of the LTCG tax provision (only appreciation in stock prices over and above the closing prices as on 31.01.2018 will be considered for LTCG tax purpose), the government might not have collected much LTCG taxes, as prices of most of the stocks have not crossed the closing prices of 31.01.2018. But the reintroduction of LTCG tax has negatively affected the investors' sentiment and the markets have been in negative territory since then. SEBI's reclassification of mutual funds has mandated large-cap mutual funds to weed out mid and small cap stocks from their funds.

While prices of large cap stocks are gradually declining, mid and small cap stock prices are crashing like never before. Hundreds of mid and small cap stocks are quoting at yearly lows and many at multi year lows. Corporate profits for the quarter ending December 2018 have belied investor expectations, aggravating the fall in an already negative stock market.

Automobile, Telecom, Cement and Metal companies are facing major headwinds. During this year's festival season, automobile companies have posted a near zero growth in sales - industry leader Maruti Suzuki has posted a 17% drop in Dec'18 quarterly profit. Cement industry's pricing power is badly affected by muted construction activity - industry major Ultratech's quarterly profit has declined by 14%. Steel industry is facing headwinds from a slowing Chinese economy and negligible capital investments by the private sector in India. Only FMCG and Software industries seem to have escaped relatively unscathed - FMCG being a necessity for domestic consumption and software industry driven by US markets.

The plight of small and medium (SME) companies are even worse - their backs have been firmly broken - partly due to their own sins and partly due to government measures. Poor corporate governance, fund diversion, mounting debt, unrelated diversification's etc are some of the sins committed by small and medium industry.

Even the audited accounts of some of SME companies are suspect in the eyes of investors. In many SME companies, statutory auditors have resigned expressing their lack of confidence in the information provided by the company managements. Share prices of well known SME companies like Kwality, Manpasand Beverages, Vakrangee, LEEL electrical etc have dropped by more than 90% during the year, on account of corporate governance concerns.

Due to mounting debt and possible defaults on bank loans, share prices of even established groups like Zee/ Essel group companies and Anil Ambani group companies are crashing. Government measures like demonetisation and bumpy implementation of GST have also considerably slowed down the SME sector.

Due to the contagious effects of IL&FS fiasco in the financial markets, liquidity for NBFC and Housing Finance Companies (HFC) was adversely affected. The stock prices of many NBFC and HFC companies have crashed by more than 50% in just a few months after the IL&FS crisis broke out. On account of mounting NPA's and increasing bank frauds, there are no takers for PSU bank shares even at throwaway prices.

2018 was a tumultuous year for Indian capital markets - the net outflow of funds by foreign institutional investors (FII's) in the equity markets was a significant USD 4.6 billion (about ₹35,000 crore) and the outflows in debt markets are even higher, USD 7.6 billion (about ₹ 52,700 crore) during the year. To put it in perspective, FII's have been consistent net investors in Indian capital markets during past several years.

All in all, it is not a rosy picture for the capital and financial markets of the world's fastest growing major economy.

(The author is a retired corporate professional and a freelance writer.)