It was a manic Monday for Indian stock markets with the Sensex hitting the lower circuit of 10 per cent and trading on both the BSE and the NSE halting for 45 minutes. Indications of a sharp decline on opening were visible early morning from the SGX Nifty futures, which trade on the Singapore stock exchange. The index was down 12 per cent in early trades. This decline was much sharper than the other Asian indices, which were sporting much milder declines, between 2 to 7 per cent.

So, what was the SGX Nifty implying and why did our markets crash the way they did? There are two proximate reasons. One, the US was about to revise the number of COVID-19 cases to display the actual number of cases in the country and Indian authorities had also indicated that they would be following suit.

There was panic that once the numbers are extrapolated, actual cases in both the US and India could run in to many hundred thousands. The fear regarding the level of preparedness of Indian authorities to handle a medical emergency of this scale could have made foreign investors stampede for the exit.

The other reason was SEBI’s circular issued after market close on Friday. It was intended at curbing market volatility and protecting smaller investors. But both the objectives were not met.

SEBI’s measures

The market regulator acted in good faith attempting to clamp down volatility. But the regulator needs to have seen the experience across markets after such curbs before acting. Such measures worked in the Chinese markets because the decline there was mainly due to domestic issues. In market crashes led by global risk-off trades and deleveraging, such curbs have always been ineffective.

SEBI’s measures were also lighter on smaller traders, allowing them to trade naked long and short positions in index derivatives up to ₹500 crore. While the shrinking market-wide position limits in some stocks may hurt to some extent, the blow was softened by allowing them to roll over their positions.

FPIs hit hard

Foreign portfolio investors have however been hit hard by the Circular because they can henceforth trade in equity index futures contracts only up to ₹500 crore and equity index options contracts of another ₹500 crore.

This limit is miniscule for these traders. Beyond this limit, FPIs’ short positions in index derivatives (short futures, short calls and long puts) should not exceed (in notional value) their holding of the stocks.

They can take long positions in index derivatives (long futures, long calls and short puts), beyond ₹500 crore, if they give cash, government securities, T-Bills and similar instruments.

What is worse is that SEBI has increased the penalty for breaching the limits to 10 times of the minimum and 5 times of the maximum penalties specified by the stock exchanges / clearing corporations.

Measures backfire

It is obvious that the measures of the regulator are back-firing in a big way. What SEBI has effectively done is to shrink the liquidity in domestic markets by imposing limits on both the ‘buy’ as well as the ‘sell’ side in index derivatives. Also, shrinking position limits will also reduce volumes, albeit over the next one month only.

The regulator seems to have overlooked the fact that there are a large number of foreign traders, hedge funds, pension and mutual funds, trading Indian index futures as well as single stock futures on the Singapore stock exchange. The trading in Nifty futures on the SGX is almost equal to the trades on the NSE. With the possibility of liquidity shrinking in domestic exchanges, trading on the SGX will only go higher.

This was witnessed on Monday morning when the SGX Nifty futures had already breached the lower circuit filter for the Nifty 50, before market opened in India. SEBI has, unintentionally allowed the trading on SGX to get the upper hand now.

It’s all very well to say that domestic institutions will support the market, since money coming through MF SIPs is sticky, but it needs to be remembered that FPIs hold over 20 per cent of the total market capitalisation in India; and if free-float market cap is seen, their share is over 40 per cent.

Also they tend to act together as a homogeneous unit during extremely volatile phases, thus posing a strong force that is difficult to counter. SEBI need not have taken these actions when the markets are vulnerable.

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