On February 28, Indian finance minister Yashwant Sinha announced an annual budget that should have given a strong push to economic growth. Tax cuts, a sharp cut in interest rates and a raising of the ceiling on foreign portfolio investment in Indian companies should have given the stock markets the boost they badly needed.
The markets cheered, rising 5% in two days. On March 2, though, the Bombay Stock Exchange 30-share Sensex index dropped like a stone, losing 4% in a single day. The events that followed spawned a huge crisis on the stock markets, rocking the foundations of the 125-year-old BSE, India’s second-biggest stock market, forcing defaults on, among others, the Calcutta Stock Exchange, the third-largest bourse, and threatening to spill over to India’s banking system.
It began when Anand Rathi, the BSE’s president, was charged with insider trading. Rathi had allegedly sought information on some traders’ open positions from the exchange’s surveillance division on the day the market fell. He allegedly passed on that information to others who sold heavily, imposing severe losses on those traders. The Securities Exchange Board of India (Sebi), the market regulator, suspended all the BSE’s broker directors, began an inquiry into 14 brokerage firms and barred Rathi’s firms from trading.
Rathi has challenged this in court. Sebi also banned short sales and increased trading margins. The market sank further even as the finance minister assured parliament that the stock exchanges would be turned into corporations and the markets made safe for investors.
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Rumours of a payment crisis at the Calcutta Stock Exchange, stoutly denied by exchange officials, had Sebi despatch its officials there. They found that there had indeed been defaults. CSE officials finally instituted default proceedings against three traders even as smaller defaults occurred on some other exchanges, including the BSE. Alarmed when the value of the collateral they held shrank and some guarantees given to traders were invoked, banks sold shares.
One co-operative bank in the western state of Gujarat was forced to close to business for a few days as panicky depositors began clearing out their accounts. The bank allegedly has a large equity exposure. Depositors at other local banks began getting nervous. Large state banks were reluctant to lend to the local banks in the inter-bank market. The banking activities of the ailing Madhavpura Bank were curtailed, and a new manager has taken charge there, on the direction of the Reserve Bank of India, the central bank.
Last November, the central bank relaxed rules allowing banks to invest up to 5% of their advances in the stock market and lend more freely, taking shares as collateral. Some private and foreign banks began eagerly doing this, and though the total exposure of Indian banks to the stock market is under 2% of their assets, many banks began selling stocks. The central bank, which has asked for details on their exposure, might impose some curbs.
A merger between Global Trust Bank and UTI Bank is also under the spotlight. GTB’s shares reportedly moved up sharply before the share swap was announced, and Sebi is investigating whether there are any links with the bank’s broker clients.
Before the early 1990s, when Sebi was set up as a statutory regulator, most of India’s 23 stock exchanges operated as closed clubs of brokers and were poorly regulated.
India has rapidly introduced electronic and paperless trading in recent years, greatly extending the reach of its markets to far-flung towns and expanding small-investor numbers to an estimated 30 million.
Trading soared but most remains speculative, with just 10% of trades actually being settled. This is because exchanges have an archaic practice of settling trades once a week, allowing traders to take positions during the week and square off trades before they need to be settled. Moreover, since different exchanges settle trades on different days, punters arbitrarge between them. High levels of speculation make investing a hazard for small investors.
In line with the global trend, India has seen a boom-bust run on IT stocks. Yet although investors lost their shirts as elsewhere, some stocks, aptly named momentum stocks, were run up sky-high by speculators over the past year.
Their sudden collapse and poor governance at the exchanges led to large defaults. The share price of one telecom – Himachal Futuristic – which has high-profile investors, such as Australian entrepreneur Kerry Packer, is down to Rs203 from a high of Rs2,174.
The present crisis points to the urgent need for reform in India’s markets. Governance has become suspect and the regulator is looking at ways to separate ownership and management to better effect. The National Stock Exchange, the biggest and newest Indian exchange, is run by professionals, and is being held up as an example.
Jayanth Varma, who sits on Sebi’s board and its risk management committee, says the margin system and settlement of trades in 200 stocks will come in line with international practice by July. Traders have complained that this would bring trading volumes down sharply. Many fear they will lose business. The present crisis has shrunk both anyway. This might be a good time to push ahead with reforms.
