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D. Murali

AN interesting paper, though written sometime back, is "Policy Issues in the Indian Securities Market", by Ajay Shah and Susan Thomas. It finds a place in a 2004 publication of Oxford University Press, "Reforming India's External, Financial, and Fiscal Policies," edited by Anne Krueger. Part history, part critique, the work has inputs for market watchers.

Okay, let us rewind back about a decade, when we touch a sore point in the history of stock markets. Remedy came in many ways, one of which was "an unusual policy intervention" — the setting up of the National Stock Exchange. It would come as news for many that the NSE was "a pioneer among securities exchanges in the world in using a demutualised structure, where brokerage firms do not own the exchange." The Bombay Stock Exchange, in comparison was already more than a century old then, but the authors note that the competition between the NSE and the BSE is "unique by international standards". How? "Both exchanges are in the same city and have the same trading hours. All major stocks trade on both exchanges, so the exchanges compete for order flows and not just listings."

One would not normally expect a B. Tech in Aeronautical Engineering, from IIT Bombay, and a Ph. D in economics, from the University of Southern California, to explain things in a simple manner, but Ajay Shah can flout such a myth.

Thus, when explaining "counterparty credit risk", he would write: "Electronic trading plays a role in reducing the search cost associated with finding a counter-party... When economic agents are exposed to the risk that transactions might fail because the counter-party defaults, it raises the cost of transacting."

The whole industry of securities revolves around funds and they have to flow at two levels: One, between securities firms and clearing corporations; and two, between individuals and securities firms. Since these do not flow fast enough, a suggestion the paper offers is to leverage on the infrastructure of banks that have pioneered high-quality technology.

"We can think of dividing all banks in India into two groups: "Class A banks", which have the above infrastructure, and "Class B banks", which do not. A small electronic payments system could be rapidly established between all the Class A banks." The tax department is already going ahead with something similar with its new online tax accounting system (OLTAS) and networked banks.

Towards the end of the paper, the authors look at the NSE's working. "While the NSE has been an extremely successful organisation, there are two important areas of concern." What are they?

One, `capture', the bane of any public sector organisation; "now that the NSE is the most important securities exchange in the country, there is likely to be significant interest on the part of political actors to capture the NSE and derive rents from it."

And, two, `cost minimisation and innovation'; in the absence of competitive pressure, "there is a real possibility that the NSE may be weak on cost minimisation and innovation in the years to come."

The remedy may lie in globalising the country's financial sector, notes the paper. This would put competitive pressure on the NSE through Indian products traded offshore and vice versa, feel the authors. For example, "transaction charges in NSE-50 futures trading at Singapore have been an important source of pressures for the NSE to lower charges for NSE-50 futures trading in India."

Similarly, when international products get traded on the NSE, there would be incentive for cost minimisation.

That would be something to ultimately benefit the small investor. But before that we would first need a stable government and politicians not too much in a hurry to indulge in rent-seeking.

dmurali@thehindu.co.in

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