Market Stabilisation Fund: Recipe to drain exchequer?
Jun 7, 2004
By Sucheta Dalal
The demand for a ‘‘Market Stabilisation Fund’’ to iron out price volatility has gathered momentum in India after May 17, especially since the market meltdown was stemmed after the 15 per cent fall, when Indian institutions turned buyers and managed to allay the mad panic. Several brokers pitched for a market stabilisation fund to Finance Minister P.Chidambaram in Mumbai last week. Earlier, G.N.Bajpai, Chairman of the Securities and Exchange Board of India (SEBI) spoke of creating a ‘‘Contrarian Fund’’. The Reserve Bank of India (RBI) also wants a market stabilisation fund to control volatility in the forex market and commodity market regulators want a ‘price stabilisation fund’ to prevent price distortion due to speculation.
Almost every South East Asian country has experimented with different versions of market stabilisation funds after the ‘‘Asian crisis’’ began in 1997. Thailand, South Korea, Japan, Malaysia, Hong Kong, Taiwan and China have all tried price stabilisation of some sort in the last decade when foreign investment began to exit in a hurry. Some measures met with initial success and in Hong Kong, the stabilisation fund even made a hefty profit. But on the whole, there isn’t enough evidence to prove the market intervention measures are anything more than government sponsored price manipulation.
A study by the Asian Development Bank in 2001, titled Rising to Asia’s Challenge; Enhanced role of capital markets says that many forms of volatility controls have been introduced in Asian capital markets. The more popular measures of keeping prices from falling during panic selling are margin regulations, circuit breakers (including trading halts, price limits, and contingent restrictions on certain types of orders), stock-market stabilisation funds, and securities transaction taxes. But it says, ‘‘The efficacy of these devices in lowering volatility and correcting large order imbalances is debatable. Even if they do reduce volatility, the benefits of reduced volatility might well exceed the cost of interrupting the price discovery process. As for stock-market stabilisation funds, their objective of sustaining share prices conflicts with market efficiency. Very often, government intervention in the market works in the short run but at far too great a cost to capital-market development’’.
In the Indian context, let us try to identify possible contributors to the price stabilisation fund. A few countries created such funds by inviting subscription from market players; often, government diktat forced large financial institutions to fork out the corpus. Otherwise, huge incentives were offered to encourage investment. In one case, banks and other investors to the market stabilisation fund were allowed to defer stock losses for a period. Government ministries in South Korea worked at creating a ‘‘a large buying force in the stock market’’ by ‘‘softening the restrictions on corporate pension funds’’ to invest in stock markets. In China, pension and insurance funds, the postal savings system, state-owned corporations, and private companies with close ties to the government had contributed to its stabilisation fund.
Can we envisage compulsory contributions in post-liberalisation India? Especially when the Employee Provident Fund account already has a massive hole in it and we have seen scamsters (who ran the dubious Home Trade) misusing provident fund money by corrupting its trustees. Encouraging pension or provident funds to participate in risky market stabilisation efforts, with or without a government guarantee, are recipes for disasters.
On the other hand, a Stabilisation Fund could be carved out of contributions from brokers and market players could work, but only if the government offered enough sops to offset the risk. But this will be the cost of revenue collection from a high-tax paying segment.
Those who are demanding a market stabilisation fund must also remember that India’s investor population is an insignificant two crore or less. And it will be politically impossible to sell the concept even to middle class Indians if it involves a contribution from the exchequer. If the fund fails in its objective or is quickly depleted, we will be in for massive controversy and investigation. The communists are also bound to oppose such a move. One can already imagine A.B.Bardhan and Sitaram Yechury telling journalists that ‘the stock markets can go to hell’ before public money is earmarked for propping up stock prices.
There are plenty of other reasons why market stabilisation experiments may not work in India. For starters, we have first hand experience of the double debacle at Unit Trust of India (UTI) and how reckless chairmen, under pressure from politicians, destroyed a mammoth mutual fund and the trust of its investors. All through the 1980s and 1990s, UTI acted as a market stabilisation fund, operating under the instructions of the finance ministry. Calls from the ministry were notorious for asking UTI to bail out industrialists who speculated in their own company shares on stock markets and found themselves trapped; or, to help influential companies place expensive equity and dubious debt with the Trust.
After the demise of UTI as it existed, and the privatisation of insurance, politicians probably feel lost without a convenient handmaiden to do their bidding in the capital market. The Market Stabilisation Fund will probably play without even the facade of independence. For that reason alone it needs to be opposed.
Another issue that has been raised by critics of stabilisation efforts abroad is that people in charge of managing such funds usually have little market experience. Other problems of government managed funds, such as leakage of sensitive trade data and front running, also hobbles their effectiveness. Consequently, they could end up sucking out hundreds of crores of taxpayers’ money by meddling in the price discovery process and attempting to push up stock prices.
The government and votaries of a Market Stabilisation Fund must consider two conclusions of the ADB study with respect to volatility controls and market intervention. It says governments must ‘‘refrain from direct or indirect intervention in the equity and derivatives market’’ using the money of financial institutions or price stabilisation funds. Secondly, it says that the efficacy of various mechanisms for reducing market volatility must be thoroughly analysed using local market data. So far, neither the regulator nor the two national stock exchanges have figured out what caused Manic Monday or the reason for sharp intra-day volatility over the last five months.