Even a cursory glance would indicate that the Governor was not addressing the issue of a volatile stock market. He was more concerned with volatility in portfolio flows and their quality. That is a substantially different topic, more within the domain of a central bank than volatile stock markets.

Issue is corporate governance: Baseless arguments linking stock market volatility and FII flows and ownership have been put forward before. A link between stock market volatility and FII flows is, however, not that easily established.

There are several other factors that cause market volatility. Factors such as earnings outlook, interest rates, political environment, global equity and commodity price trends, and policy changes, to name a few, have as much effect on market volatility as changing shareholding patterns.

Corporate governance is more important than any of these factors. Stocks of companies perceived as dependable are less volatile than those that score lower on corporate governance. This is why HDFC is less volatile than SBI, and Infosys less volatile than Wipro. Incidentally, all four stocks are heavily sought after by FIIs.

Market volatility: More importantl, it may also be difficult to establish that the stock market is excessively volatile. Some facts:

The volatility of daily returns of the Sensex has come down sharply from the levels they were at in 1992.

Daily return volatility of Sensex and Nifty in 2003 was comparable to volatility of a few of the indices in developed markets.

Daily return volatility of Sensex and Nifty increased in 2004 compared to 2003.

Despite increase in volatility in 2004, Sensex and Nifty continue to be slightly less volatile than market indices in Brazil and South Africa. Brazil and South Africa are two of the many emerging markets that are competing with India for FII flows. Volatility in markets in Brazil and South Africa also increased in 2004.

Let us focus on the increase in volatility in emerging markets in 2004. Prima facie this would indict the FIIs. This suggests that wherever FIIs go they cause volatility in prices. We would, however, be ignoring a number of other factors. For instance, can we discount the impact of the surprise election verdict in May 2004? Nifty and Sensex suffered a fall of 12 per cent in a single day in May 2004.

Again, how are we to discount the impact of rising oil prices, the outcome of the US Presidential election and increase in interest rates in the US? We also need to consider margins. Margin- money collected from traders facilitates smooth settlement of trades. When the market is caught in a frenzy, however, these margins accentuate volatility.

FIIs, an integral part: It could, of course, be argued that market volatility induced by surprise events are accentuated by the presence of FIIs. This, too, however is a specious argument. Investors, whether domestic or overseas, will respond in the same way to shock events. Lower liquidity that will result from the absence of FIIs will lead to more volatility.

This also takes us to the argument of whether we need FIIs. Much water has flowed under the bridge since India decided that we need FIIs and started actively courting them. What we can do is regulate them and mitigate any deleterious effect their presence may be causing.

This is precisely the subject of the Governor's speech. Instead of focussing on the regulation aspect, getting embroiled in needless sideshows such as FII-induced stock market volatility will only detract from the importance of the debate.

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