The Hindu Business Line : An analysis of black Monday events in stock markets

THE rapid fall and recovery of the markets may have resulted in high financial loss to investors on actual or notional basis. But to my mind the biggest loss is the credibility of prices. There is a great lesson to be learnt from this volatility that we saw and no more proof is required to show how fragile and shallow the Indian stock markets are.

There has been a suggestion to set up `market stabilising fund' to intervene under such occasion for providing stability. Many other analyses are being made and will be made.

Let us examine a few of them.

The concept of market stabilising fund is basically against the tenets of market mechanism. If the objective of the fund is to support the markets, as it is prone to risks of loss of capital, the operation of the fund also will be extremely complicated. It should not so happen that we end up funding the speculative losses in the markets through this fund.

To my mind, there can be no such fund. This is not different from the minimum support price for various agricultural markets that we see. Instead, we need stabilisation measures. For example, the fund may provide temporary lines of credit for 3-4 days to help the situation. The announcement by the RBI to support such crisis should be a starting point for provision of temporary credit to clearing corporation.

SEBI has rightly said trade guarantee funds (TGFs) are more than adequate to meet any eventuality. However, the TGF is in the form of liquid shares, bank fixed deposit receipts, bank guarantees and cash. While bulk of the fund is in near cash equivalents they require certain procedure to be followed and some time is required to convert them into cash.

In the absence of line of credit the exchanges go into a tizzy to collect hard cash, which is done by collecting money in form of advance pay-in, increasing margins during the market time, debiting broker's account for pay-in after banking hours ahead of regular pay-in time by pressing the panic button etc.

This in turn leads to a panic situation in the market place as the brokers desperately try their best to keep the terminals going. Shutting down of terminals in such times gives a wrong signal to investors. The panic is also transferred to the investors since the brokers force the investors to square up open positions and also sell additional stocks in order to meet their commitments.

The next big shortcoming that we saw in the crisis was the banking infrastructure in terms of remittance and payments at different centers. The online banks have a system of putting cheques in box. The cheques are then sent for clearing and the amount is shown as float. It takes any where between 4-5 days for the whole process to complete. In such situation, demanding advance pay-ins is nothing but an invitation for panic. Some banks do cooperate by giving temporary overdrafts against float but most banks do not have guidance from RBI to help in such situations.

The next issue is of structural deficiencies in the market. With the absence of physical settlement of shares in derivatives market, we have willy-nilly permitted free fall by short sale without any obligations. Physical settlement of derivatives contracts bring about a stabilising effect on the market since goods move from cash to derivatives markets and one sided movement and volatility is avoided.

Successful introduction of physical settlements need a vibrant Margin Trading and Stock Lending Scheme. Neither is in place. There was a proposal for permitting the clearing corporations to do stock lending. Secondly an investigation is also required in the matter of margin trading. The volumes reported to exchanges on margin trading are miniscule compared to the alleged stock sold by various brokers.

The next issue that needs to be looked at is the depth of the market. We need more good quality paper to ensure that our stock markets represent all sectors of the markets. For example transport sector would be represented if we have trading in Indian Rail. Air India, Airport Authority of India, National Highway Authority, Metro Rail, and Indian Airlines etc are listed on the stock exchanges.

The last suggestion is on the handling of the crisis situation by various regulators associated with the stock markets.

All support measures, be it in form of better financing mechanism for trade settlements or margin trading for medium term stability or permitting social security schemes to invest in markets in a small way for long term stability, must be implemented urgently. Failing which, it will be no better than a traffic jam where government facilitates production of millions of cars but does not invest in roads!

The author is Managing Director of Asit C Mehta Investments Intermediates. The views expressed here are her own and not necessarily those of her firm.