Finance minister P Chidambaram plans to visit the Securities and Exchange Board of India next week. Clearly, the 15 per cent intra-day fall in the stock market, that too in just over 15 minutes of trading on May 17, is a big worry for the government. And it correctly should be.
Although the Indian markets proved their resilience and adequate risk containment measures by getting through manic Monday without any broker default, such extreme nervousness and volatility indicates a dangerously weak and illiquid market.
The finance minister must examine the lack of liquidity that was exposed on May 17 when stock prices fell on extremely thin trades. There simply isn’t enough depth in our capital market. The retail investor population has remained stagnant for over a decade and after the collapse of Unit Trust of India, there are no significant domestic institutional investors. The mutual funds industry hasn’t taken off, despite many sops from the government; and many funds have preferred to focus on high net worth individuals rather than to build a large retail base. Public sector banks and financial institutions control nearly 80 per cent of Indian financial assets; but they stay away from the secondary markets even when quick profit opportunities like those on manic Monday present themselves. This has left the field open for foreign institutional investors (FIIs) and they are the dominant players in the Indian market today.
Curiously, neither regulators nor stock exchanges are paying enough attention to the large-scale churning of portfolios by FIIs. The lack of liquidity was painfully evident in the first half hour of trading on May 17 when prices went into a free fall and there were simply no institutional investors with a contrarian view, who stepped into to buy without being prodded by the government.
Yet, after the second circuit break, trading volumes shot up as soon as Indian institutions turned buyers. FIIs alone bought and sold over Rs 2,500 crore of shares that day and volumes were normal after trading resumed a second time. These volumes often create an illusion of liquidity and depth, but could well be a cover for intra-day price manipulation.
The Indian stock market has always been manipulated by large investors or through cartels. Buying or selling stocks that comprise the BSE Sensex has usually been the swiftest way to manipulate investor sentiment. But dubious operators usually needed plausible sounding rumours to engineer a fall of 100 to 120 points in the Sensex.
Not anymore. On innumerable occasions in the last year, we have seen intra-day swings of anywhere between 100 to 200 points without any explanation. Often these swings are not even reflected in the closing stock prices. A sharp rise or fall of 50 to 60 points in the Sensex has become so routine that SEBI doesn’t even bother to order an investigation. Moreover, the many investigations that SEBI has ordered in the past have never led to the detection of mischief or punishment of manipulators.
Another grey area is the nature and quality of derivatives trading permitted to FIIs and the inadequacy of published data about their investment. While Indian mutual funds are not allowed to trade in derivatives, except to hedge their portfolios, FIIs have no such restrictions. Similarly, in the cash market, nobody has bothered to analyse large FII trading volumes in a relatively liquid market.
FIIs, on the other hand, argue that they were the biggest buyers in 2003-04 (they invested $10 billion) and carry the maximum risk of losses if markets continue to slide. Indian markets are so illiquid that they find it difficult to hedge their cash market risks and even the arbitrage opportunities created by their hedging remain unexploited by domestic investors. Our domestic financial institutions continue to be ignorant or reluctant to trade in the derivatives market and exploit profit opportunities. And they seldom leverage their portfolios skillfully to make money. None of them saw unique buying opportunities when markets crashed on May 17. They were prodded into action after confabulations between Dr Manmohan Singh and former finance minister Jaswant Singh.
Mr Chidambaram may also want to concentrate on restoring retail investor confidence. India cannot boast of a healthy economy with a vibrant capital market if its investor population has remained stagnant for a decade. The FM has often said that investor sentiment has been badly battered by repeated scams. The slow inquiry process and bungled investigations then allow scamsters get away scot-free.
Mr Chidambaram must expedite investigation into the UTI collapse following the Ketan Parekh scam and probe the nexus between its then chairman and various companies and brokers such as Cyberspace Infosys and Ketan Parekh’s cronies. If this government plans to put disinvestment on the back burner, it is fairly certain that large chunk of UTI Mutual Fund (UTIMF) will not be sold to a strategic investor. If UTIMF remains a government undertaking, there is no guarantee that the debacle of 1998 and 2001 will not be repeated under some other chairman.
The government now faces the likely wrath of 10 to 12 lakh new investors lured to the capital market in March 2004, by what they thought were safe public sector share offers. The stocks were sold to them at a two to three year high and are now quoting below their offer price. The poor infrastructure of registrars and transfer agents has meant that many investors have yet to get their share application money refunded. In a lot of cases, especially bank issues, investors have been allotted physical shares and have lost the opportunity to sell out and contain their loss.
Finally, the quality of investigation remains a major area of weakness at SEBI. The regulator has ordered several probes into market manipulation and mischief by registrars and investment banks, which have not led to any deterrent punishment so far. Mr Chidambaram must crack the whip to ensure the disciplinary machinery of the regulator either works faster or is completely overhauled. These measures will go a long way towards restoring investor confidence.