Are investors trapped ‘between RBI and LIC’?

The LIC IPO made an unusual market debut on May 17. It had witnessed a relatively strong demand on the issue (oversubscription of about 3 times) and had declared pricing at the top of the range. However, its first trading day saw the stock settle at close at Rs 872/share, down 8 per cent from the issue price. While the government got its Rs 21,000 crore ($2.7 billion) by divesting a 3.5 per cent stake in LIC, the investor community is perhaps losing out, as the stock price has continued to slide.

This is happening even though it initially appeared that the government had been realistic. It had initially planned to sell 10 per cent of its stake and raise $12 billion but lowered its targets twice in response to altered market conditions.

The first reduction to 5 per cent, announced in early February, was perhaps in response to the fact that FPI/FII investors had turned net sellers since October 2021. FPI/FIIs have about 20 per cent market share of India’s equity market. Their return expectations are influenced by the volatility of the rupee. The rupee has been weakening in recent months on expectations of the US Federal Reserve shifting to tight money policies to fight inflation in the US.

Meanwhile, the RBI was continuing with the looser monetary policy adapted to revive growth and investment, post-pandemic. The FPI/FIIs have, in the seven-month period ended April 2022, withdrawn a net of over Rs 1.65 lakh crore from Indian equities. Then, when the Russian invasion of Ukraine began on February 24, further battering global markets, a further lowering of targets occurred. The LIC IPO was finally filed to raise around $2.7 billion from the sale of a 3.5 per cent stake, just a third of the original plan.

The IPO pricing at Rs 949 (with different discounts for employees, policyholders and retail investors) had initially been considered investor-friendly as it was modestly pegged around ‘embedded value’ while private sector insurers are seen to quote at two to three times their embedded value. The embedded value is a measure of future cash flows of life insurance companies and a key financial metric for insurers. A detailed exercise to calculate the embedded value of LIC and also obtain investor feedback had been carried out. Yet, the market opening was disappointing. Why?

The oversubscription occurred primarily because of a huge retail push. Large oversubscriptions were mainly in the policyholders (6 times) and employee (4 times) sub-segments. An acceleration in the opening of Demat accounts has been witnessed in the post-Covid months. These have jumped from 40 million in March 2020 to over 70 million accounts now. This rush towards the stock markets is a behavioural response of individual investors to the sustained RBI effort to reduce interest rates, often through unorthodox measures, despite a worrying increase in retail inflation, to stimulate the economy through monetary instead of giving space to fiscal policy. Money supply growth had significantly exceeded GDP growth. Newbies thus started getting lured towards stock markets as bank/post office saving schemes were now earning negative real rates of interest. The last year saw a 38 per cent increase in assets managed by the mutual funds industry.

Alongside came a concomitant increase in the number of brokerages and competitive spirit, which helped to popularise margin-funded share trading/IPO subscription schemes. This implies that orders in excess of available cash get placed but with inbuilt auto ‘stop-loss’ safeguards. These get triggered the moment there is margin shortfall. It is possible that these ‘stop-loss’ sales got triggered in this IPO and are now cascading through the system.

What of the future? Some market commentators are suggesting that investors are likely to experience continued volatility though the stock may ultimately do well given LIC’s inherent strengths. This lukewarm stance is because of the perceived difference in the approaches of the US Fed and the RBI in fighting inflation. The US Fed, apart from increasing rates, has been releasing ever more hawkish statements promising future rate increases. RBI, though quick to respond with its own, off-cycle, 40 bps increase (plus an increase of 50 bps in the CRR), has been somewhat reserved about its future approach, though Indian retail inflation has now crossed 7.5 per cent and wholesale inflation 15 per cent.

This could be because it perceives it to be its responsibility to minimise the interest burden of the government’s budgeted market borrowing of Rs 15 lakh crore for this year. It seems that this reservation in taking a more hawkish stance is impacting the rupee, which has touched a new historical low, below 77 to a dollar. The continued slide of the rupee, apart from importing inflation, could continue to deter FPI/FII/NRI interest in the Indian stock markets. The investors of the LIC IPO may thus have to be patient while RBI sorts out its own ‘devil versus deep sea’ conundrum.