India Investors Head for the Exits

Shares plunged 12% in the two trading days ended Jan. 22, as foreigners withdrew some $1.5 billion from the Mumbai bourse

by Manjeet Kripalani

Reaction of Indian investor to today's stock market decline GETTY IMAGES

After New York, London, and Shanghai, now it's Mumbai's turn. After months of being on a meteoric, gravity-defying rise, Indian shares have spent the past two days in free-fall. On Jan. 21 the stock index sank 1,408 points, or 7.4%. On Jan. 22, barely a minute or two after the market opened, stocks promptly plunged another 11% and prompted a one-hour trading freeze. Finance Minister P. Chidambaram had to make a national TV appearance, pleading for calm. There is "no reason at all to allow worries of the Western world to overwhelm us," he said.

But many of the most important investors in India's market are Westerners themselves, and they're feeling pretty overwhelmed right now. India is highly dependent on global financial markets to fund its macroeconomic growth. According to a Jan. 21 report by Morgan Stanley (MS), more than three-quarters of the capital flowing into India's stock market comes from foreign portfolio managers.

After the market re-opened on Jan. 22, Indian shares suffered their largest intra-day fall in years, down at one point by 1,736 points, or 11.3%, before recovering some ground and closing down 5% for the day. Fleeing foreigners—the mainstay of the Indian stock market— withdrew about $1.5 billion, leaving locals at sea. "We've got a systemic failure, that's what," says Surjit Bhalla, economist and manager of the Oxus Fund in New Delhi. "It's a panic."

Ambitious IPOs Affect Market Liquidity

Until recently, India has also had the robust participation of local retail investors, making Mumbai shares skyrocket. With gross domestic product growth rates upward of 8.5% and annual corporate profit growth of more than 20%, locals saw little reason to worry, and the country's business elite confidently planned a spate of mega-public offerings that would mop up billions of dollars from the market.

On Jan. 11, major retailer Future Group's financial services arm, Future Capital Holdings, put $1 billion of its stock on offer, and on Jan. 12 Reliance Power declared itself ready to raise $3 billion from the market, the money to be used for ambitious power projects. Encouraged, BSNL, India's largest telecom operator, announced it would be ready to raise $10 billion from the market over the next year.

But the timing of these ambitious initial public offerings has coincided with the global market meltdown. In addition, investors in India, both retail and institutional, have reportedly borrowed heavily to participate in the IPOs, putting down a cash advance worth 10% of the estimated value of the shares applied for. That means that until IPOs actually list—Reliance Power is due to begin trading in early February—investors' money is locked in. That, say market analysts, has sucked out the liquidity from a market that is already seeing the flight of foreign money.

Rumors of Tougher Margin Requirements

Another reason for today's panic: rumors that regulators were toughening requirements for margin trading. Consequently, when the market opened on Jan. 22, selling was so fierce that the market hit the circuit-breakers, forcing a halt in trading. "These allegations are baseless," says a senior manager at the National Stock Exchange.

Economists say the Reserve Bank of India, India's central bank, now needs to ease margin requirements and pump liquidity into the market. "This is an extreme situation, not too different from the subprime story," says economist Bhalla. While investors are anxiously awaiting some sign from the central bank, nothing was forthcoming by closing time on Jan. 22.

Despite the current turmoil, most economists agree that India's economic story is still a happy one in the medium to long term. The current government may not have introduced new reforms, but corporate India is performing in stellar fashion. In the quarter ended Dec. 31, 2007, profits were up more than 20% across the board. Cement maker Grasim Industries saw net profits rise to $140 million, up from $112 million in the quarter ended Dec. 31, 2006, an increase of 25%. Lupin, a drugmaker, saw its profits rise to $43 million from $14.1 million during the same quarter, while Bank of India recorded earnings of $129 million, up from $64 million in the year-earlier quarter.

Says Ridham Desai, managing director of Morgan Stanley: "The froth has gone off the market." He believes that, while India is fundamentally sound, there will be more volatility in the coming days, with commodity stocks dependent on the global cycle being affected the most. "Watch this space a month from now," says Sunil Shah of Bombay's Khambatta Securities. "Valuations are compelling, at last." He predicts the market is a fair buy at 18,000.

With Nandini Lakshman in Mumbai

Kripalani is BusinessWeek's India bureau chief.