Owners of Indian companies may have to sell ₹3.7 trillion worth shares to meet the budget mandate-- and that may drive down stocks rapidly

• Nirmala Sitharaman's budget said that it would increase the number of free-floating shares, the ones that are available to public including foreign portfolio investors.
• The budget proposal said that amount of mandatory free float will be increased to 35% of all shares of a company from the current 25%.
• This would mean promoters of companies will have to sell shares worth ₹3.7 trillion, according to Credit Suisse's Neelkanth Mishra.
• Such high quantities of shares on sale will drive down stock prices before they stabilise.

Nirmala Sitharaman's latest budget said that it would increase the number of free-floating shares, the ones that are available to public including foreign portfolio investors. The budget proposal said that amount of mandatory free float will be increased to 35% of all shares of a company from the current 25%.

This would mean promoters of companies will have to sell shares worth ₹3.7 trillion, according to Neelkanth Mishra, co-head of Asia Pacific strategy at global investment bank Credit Suisse. "This transition may cause some volatility in the equity markets — nearly Rs 3.7 trillion of equity would need to be sold by promoters — but a reasonable time-frame to reach this threshold should minimise that," he said in a opinion piece.

Some of the fear is already visible in the market. Sensex lost nearly 400 points on Friday after the budget was revealed. The first hour of trade on Monday saw deeper cuts on the benchmark index. While a number of factors are at play, the market seems to be wary of the short term impact of the various budget provisions.

The upside

The government's move to increase the free float is aimed at getting more foreign investors into India. "The theoretical maximum that foreigners can buy affects the weight a country has. The “Foreign Inclusion Factor” for India, which is amongst the lowest in the world, should increase meaningfully once this change is implemented. A higher weight in the benchmarks means greater equity portfolio flows to the country," Mishra explained.

Assets of foreign portfolio investors-- those investing in shares and bonds-- increased by over ₹3 trillion between February and May 2019.

Word of caution

However, India has to wary not to overheat the market with fleeting foreign capital. When a strong gush of dollars enter any country, it leads to higher inflation.

Similarly, the hot money tends to leave the country at the first sign of any trouble, leading to a huge crash.

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