Economics assumes that human beings are rational. But human reactions to stock market movements are utterly irrational. When markets rise, everybody cheers. When markets crash everybody moans.
A hunt for culprits often ensues. No such hunt is ever announced when the markets are rising. In past scams, when manipulators like Harshad Mehta and Ketan Parekh sent share prices through the roof, they were hailed as geniuses and became celebrities. Some market experts cautioned that the markets had shot up to insane levels. But this plea for sanity was widely dismissed as stupid, and ordinary housewives and college kids bought frenziedly in the belief that share prices could only go up.
However, when the markets inevitably fell, the hero-manipulators were suddenly denounced as villains. They were accused of the dreadful sin of rigging markets, and thus misleading small investors. Ironically, no investor complained as long as the manipulators rigged prices upward.
The complaints began only when the manipulators were unable to rig markets any more, and prices crashed. Truth be told, the real public complaint against Harshad Mehta and Ketan Parekh was not that they manipulated prices upward, but that they failed to manipulate it upward forever. For that, this could not be forgiven.
The underlying assumption of small investors is that share prices should rise forever. Now, if the price of rice, sugar or petrol rose forever, the small investor would complain bitterly. Yet he seems to think it perfectly fair that share prices should go up forever, and very unfair if share prices crash. How greedy and hypocritical humans are!
The long run prospects of the economy are excellent. So, some investor exuberance is understandable. Yet such exuberance needs to be tempered by sharp corrections from time to time. This sends the valuable message that exuberance is no substitute for judgement.
Human beings quote many aphorisms that they seem to forget when they enter the stock market. All that glitters is not gold. Don’t be penny-wise and pound-foolish. Look before you leap. There is no such thing as a free lunch. Better safe than sorry. A fool and his money are soon parted.
All who invest in markets must remember these aphorisms. Risk and reward go together. If there were no risk, there would be no market reward. Share prices represent subjective judgements of the day, so bouts of euphoria and depression will necessarily drive share prices up and down.
Some political groups find this terrible. They deplore “casino capitalism”, and lambaste foreign institutional investors (FIIs). They cannot bear to acknowledge that FII pressure has sparked capital market reforms that have made Indian markets among the best in the developing world, far ahead of China or South Korea. FIIs were earlier reluctant to invest in a market where one-tenth of all paper share certificates were forged, settlements were delayed for months on end, and thin turnover facilitated rigging by big brokers (and by companies before every public issue).
But after capital market reforms, FIIs have flooded in. They have invested in all emerging markets, but disproportionately more in India. They have favoured companies with good governance and transparent accounting, rewarding these traits for the first time (earlier, the ability to rig markets was rewarded most). Stock market reforms and FII inflows have hugely improved the ability of Indian companies to raise equity finance for expansion. This has reduced their dependence on debt, thus reducing interest rates as well as over-leveraged balance sheets.
These political groups can see none of this. They believe only that foreign devils are making millions and paying no tax. So they demands a capital gains tax and an end to the Mauritius treaty that has been used as a tax loophole by FIIs. They seem unaware that Finance Minister is in fact taxing dividends and capital gains in ways that have made the Mauritius loophole irrelevant, and so ensured that FIIs are indeed taxed.
Stock markets have risks as well as rewards
Dividend tax is now paid by companies rather than recipients; so FIIs cannot avoid it. A transactions turnover tax is being collected in lieu of capital gains tax. This brings all investors including FIIs into the tax net, and the Mauritius route has been rendered irrelevant. Domestic crooks used to avoid capital gains tax through benami small accounts, but now cannot escape the transactions tax. Thus Finance Minister has ended tax avoidance and evasion, brought FIIs and Indian crooks into the tax net indirectly, and created a level tax playing field between domestic and foreign investors. That is a considerable achievement.
So, our problem today is not untaxed FIIs. It is the notion that markets should rise forever. They will not, and should not. We need sharp dips to remind investors from time to time that stock markets have risks as well as rewards.
