The BSE Small and Medium Enterprises Exchange CEO thinks that the exchange has the potential to list a million companies even as both the IPO market and traded volumes have dried up

The BSE SME Exchange which is likely to be launched in September 2011 expects to list 1 million potential small and medium enterprises (SMEs). "Of the total 26 million enterprises in India, around 1 million units have the potential to get listed on the BSE SME Exchange," said Lakshman Gugulothu, chief executive of the BSE SME Exchange in Hyderabad yesterday.

Unfortunately, Mr Gugulothu, new to the capital market, does not know what he talking about.

BSE has in all over 800 companies listed. Not many trade daily. Many are shell companies, which are rigged easily by operators. Moneylife writes about them in every issue of the magazine, but neither the stock exchange, nor the regulator would do much about them. To think that million SMEs can be added to this shallow and hollow market is simply ridiculous.

The overall market liquidity of the Bombay Stock Exchange has gone down sharply over the years. The liquidity is there only in the large-cap companies. Very few retail investors are there to buy shares of smaller companies. Domestic Institutional Investors (DIIs) are not yet a force. Even in the case of blue chip shares, which are traded well in a normally functioning stock market, the traded volumes come from investments by Foreign Institutional Investors (FIIs), and not from domestic investors. But FIIs hardly invest in smaller companies. In this situation, what will create the linkage between the small companies and investors?

Whenever a stock suffers from poor liquidity, investors shun them. This leads to even lower liquidity-which becomes a vicious cycle. All this would be very pronounced in case of small companies Mr Gugulothu wants to attract.

Also, due to a variety of structural problems, the Indian equity markets are in a state of coma. The market for Initial Public Offerings (IPOs) is almost dead and past IPOs have inflicted large losses on investors. To expect investors to buy shares of unknown small companies is a pipedream.

Even if there was liquidity for smaller companies, the concept of an SME Exchange is new to India and will have to prove itself to the investors. Internationally, exchanges for smaller companies have worked only in a few countries such as the US, the UK, Brazil and South Africa. There are several reasons why a small exchange-that too from a declining platform like that of the BSE-is bound to fail badly. But more about that in another article.