At a time when the equity markets remain range-bound and FIIs have been net sellers, investors and index fund managers can take solace from the fact that market liquidity is improving and so is the ease of transacting. This can be noticed from the significant drop in impact costs.

According to NSE data, the impact cost for Nifty, which stood at 0.15% in January, has steadily come down to 0.07% in the month of May, indicating the liquidity rise in the market. The difference between the original price of a share and its new price is known as the impact cost. The higher the liquidity, the lower is the impact cost. A lower impact cost means lower cost of transacting in the stock market. This makes it easy for retail investors to dip into the stock markets.

However, the average impact cost so far for the current year is significantly higher than the previous year. The impact cost stood at 0.07% on an average for the year 2007 implying an ease in executing bigger order at the exchanges.

The impact cost is important consideration for sophisticated investors, especially those who prefer to execute large orders. It is also used by index fund managers extensively. It is the impact cost that determines the extent of returns for index funds.

However, the lowering of impact cost might not be a widespread phenomenon at the moment. Rajesh Baheti of Crosseas Capital services attributes this fall in impact cost to hedging. He says, ?Hedging activity carried out by investors in the index in such uncertain times in the markets has led to higher liquidity in trading the index thus lowering the impact cost. However, as far as the individual stocks are concerned, the impact cost has gone up significantly, compared to the previous year as many of the arbitrageurs are out of work post-Budget.? Moreover, impact cost for individual scrips tend to differ.

Impact cost touched a very high level immediately after the January meltdown and fund managers complained about difficulties faced while executing bigger orders. Often managers had to break down a bigger lot of shares and wait for 20 minutes for the transaction to get consummated.

An advisor to an India-specific private equity (PE) firm, while sharing his view on the depth in the Indian markets, said, “The depth of the Indian equity markets

was on a test when Warburg Pincus sold a $560 million stake in Bharti Tele-Venture. The transaction, on the Bombay Stock Exchange, was the largest block trade ever on the Indian markets which took a breathtaking 28 minutes to consummate reflecting the poor depth of the equity markets then”. On March 15 2005,the private equity firm Warburg Pincus has sold around 6% cent of its stake in Bharti Tele-Ventures for around $560 million while continuing to hold 108.1 million shares in the company.

Going forward, key players are watching for an improvement in the impact costs as it has a direct impact on returns generated. “At a time when the rupee is depreciating at a rapid clip, a higher impact cost will keep overseas investors away” says a private equity fund manager. Moreover, an improvement in systems and processes can go a long way in reducing these costs. The move by the regulator to allow institutions with direct market access is seen to be one of the steps in improving systems.