India?s stock exchanges (SEs), which are usually more liquid than other bourses of the world, appear to be falling victim to an overall slide in trading volumes. According to circulars pertaining to illiquid securities on the SEs, there are around 315 illiquid securities at the National Stock Exchange (NSE). The comparable figure at the Bombay Stock Exchange (BSE) for the last three months stands at 1641. However, on a proportional basis, 8 out of 100 securities are illiquid on the NSE while only 4 securities (stocks, mutual fund units and other securities) out of 100 are illiquid at the BSE.
At the BSE, of the 7,500 odd shares listed on the exchange, only about 2,700 stocks were traded in the year 2007-2008 while at the NSE around 1,200 stocks were traded as against the listed 1,300 companies.
The Securities & Exchange Board of India (Sebi) had directed the exchanges to draw up a list of illiquid securities based on criteria jointly decided by Sebi, NSE and BSE on a monthly basis. Trading members were advised to exercise additional due diligence while trading in these securities either on their own account or on behalf of their clients.
Liquidity refers to the ability of market participants to undertake transactions in securities expeditiously at a competitive price and with minimal price difference between buy and sell. Typically, more the trading volumes more is the liquidity and greater the liquidity, investors are more likely to pay or receive a competitive price for securities purchased or sold with better price realisation.
Says the Sebi website, ?There may be a risk of lower liquidity in some securities as compared to active securities. As a result, your order may only be partially executed, or may be executed with relatively greater price difference or may not be executed at all.?
The head of research at a leading brokerage said, ?Apart from the falling trading volumes, other aspects such as the low public shareholding in a majority of the stocks is the reason for illiquidity. Low liquidity acts as a double whammy to the investors. First, by increasing the transaction cost both while buying and selling, and second, it becomes a fertile land for manipulators.?
The trading volumes at BSE have slid by more than 70% from the January this year till date while the volumes at the NSE have slipped by more than 30%. Economist and expert Ajay Shah also notes in its blog, ?Illiquid securities are vulnerable to odd fluctuations of prices, thus generating unusual risks for investors. They are characterised by poor information, poor research, and frequent gaps between the secondary market prices and a true valuation of the security. Illiquid securities often have market prices which do not accurately reflect future risk and return. Investors face an informational asymmetry when they buy these securities, on the secondary market and particularly on the primary market.?