Striking similarities

Sebi and investment banks have to ensure that the imminent IPO boom does not degenerate into doom as in China

By Mohan Sule
The primary market is a parasite. It survives by feeding on the secondary market. A euphoric Shanghai stock market spun off a share-sale deluge. No sooner did the Chinese controllers stepped in to cap the runaway prices by hiking margins than listed equities began displaying withdrawal symptoms, plunging 30% from the peaks. So much so that financial institutions and brokers had to pledge to step up buying. Issuers were banned from raising capital to shore up the secondary market. China’s secondary market may well hold due to all the public display of affection but will IPOs? India is on the cusp of a primary market recovery. It will be the beneficiary of any disappointment of foreign investors with Shanghai. Yet, China’s experience of boom and projected doom has raised concerns. There are striking parallels. Chinese stocks have run ahead based on the belief that double-digit growth will be the norm. A slowing economy, therefore, can pull down high-flying stocks. Hence, the desperate attempts by the authorities to cool the heated equity market. Indian shares started spurting even before the May 2014 Lok Sabha elections on projections of the rise of Narendra Modi. His stint as the chief minister of Gujarat had established his reformist credentials. Also, the low base of the last two years meant heady growth going ahead. The turn in sentiments propelled the market to cross the 30,000 level. Just like China, India has plenty of room to grow. The potential of both remains untapped due to different reasons.

The deceleration in the grinding of its manufacturing facilities, triggered by the fall in property prices, is slowing China’s growth. The glacial pace of India’s reforms is lagging behind the galloping valuations. A common area of worry is the banking industry. China’s is dogged by dodgy account keeping, hiding the true state of its bad loans. Loose lending has contributed to bubbly stocks. India’s banks, too, are weighed down by non-performing assets, immobilizing their capability to lend to new clients. If the Chinese IPO boom is the beginning of the end of the China’s growth story, is India too destined to burn out before taking off? The composition of investors is a rough indicator to determine the state of a market. Ordinary investors fuelled the Chinese primary market. Indian retail investors are returning to the ring, primarily through mutual funds. On many occasions domestic institutions have bought equities even when foreign investors were selling. The downside is that the small investors responsible for holding up the market through mutual funds might book profit in the secondary market and turn their attention to new offerings. The Securities and Exchange Board of India has shortened the listing period from the close of issue by nearly half to six days. The prospect of bumper profit in a short time span can prompt diversion of funds from listed stocks. No wonder, a frothy primary market is viewed as the last phase of a bull-run. The equity market went bust shortly after the mega offer by Reliance Power in January 2008.

The other danger is the absence of capital appreciation due to high-value offerings. There is at least a probability of gains being recycled into newer offerings. Under-subscription due to richly-priced issues or listing at a discount to the offer price has the malevolent power to destroy the primary market and, in turn, the secondary market. Many issues will be offering exit route to early-stage investors, who would want good returns on their investments. More will be from companies aiming to deleverage. With banks going slow on lending due to money locked up in bad loans or entertaining only those with good credit score, there will be no surprise if those requiring capital will be from risky but promising segments. Small and mid caps will be the most vulnerable to mood swings as money flows in and out of the secondary market, depending on the size and attractiveness of the issue in the primary market. The market regulator has gone out of its way to ensure a smooth ride for small investors by introducing concepts such as retail discounts, anchor investors, market-making and buyback as safety net. With the memory of the roller-coaster ride of Chinese stocks still fresh, Sebi has to nip in the bud any signs of irrational exuberance and become vigilant in vetting the issues. There should be zero tolerance for non-disclosures by becoming visible in cracking down on those who flout rules. Investment banks have to cap the greed of issuers by nudging them to price their shares modestly so that they can be long-term players rather than flashes in the dark.