Reining in the bull

Whether the BSE directors had used their recourse to price sensitive information or not for transactions in the market, having had direct access to the data was in direct violation of SEBI rules, observes Oommen A. Ninan.

WHEN THE Sensex crossed the dizzy 5000 mark in October 1999, Bombay Stock Exchange (BSE) brokers literally took to the terrace of Jeejebhoy Towers and released balloons. The celebration also marked their ``bullish sentimentalism'' and showed lack of market prudency - that what goes up has to come down; that the market is driven by its own dynamics.

However, the euphoria continued. By February 2000, in the days before the Union Budget, the benchmark BSE 30-Share Sensitive Index (Sensex) breached the 6000 mark and crossed 6150 on February 12, an all-time high. But the Budget on February 28 was not received well and the market fell halfway through; from the intra-day high of 5,903 the Sensex closed the day down by as much as 457 points or 7.7 per cent. Although the Sensex recovered by around 200 points in the next day's trading, the recovery proved short lived.

The Sensex, which was lacklustre in the days before the Budget unlike last year, later shot up by 177 points. The Union Finance Minister, Mr. Yashwant Sinha, it seems, expected a rise almost everyday - a bullish sentimentalism - after the presentation of his dream budget. But on March 2, the Sensex crashed by 176 points. This irked the Union Finance Ministry and prompted it to initiate an investigation into market manipulation, which was going on in the past several years.

Excessive speculation in the Bombay Stock Exchange (BSE) led by the leading broker, Mr. Ketan Parekh, is the main cause of the present fall in stock prices. He had financed all these transactions with money drawn from banks. The Madhavpura Mercantile Co-operative Bank was hand-in-glove with Mr. Parekh. The issue of pay-orders, without actual cash behind it, was the fraud by the banking system. Thus, the present crisis in the capital market as well as the banking system and the collapse of the regulatory mechanism are inter-related.

The built up position of Mr. Parekh in certain equities known as `K 10', in the normal circumstances, would not have had any major impact on the market. With the elected directors, including the BSE president, having had recourse to the price sensitive information - relating to outstanding positions, purchases and sales by leading operators - it is to be seen whether they have used this advantage to depress the prices. The Securities and Exchange Board of India (SEBI) investigation will reveal it in the next few days.

Whether they had used this information for effecting transactions in the market or not, having had access to the data was in direct violation of SEBI regulations. The regulations had very clearly indicated that the surveillance department of the broker-driven stock exchanges should be under the exclusive control of the Executive Director. The explanation even by the then President of the BSE, Mr. Anand Rathi, that the Executive Director was ineffective is no answer. In fact it is rather doubtful whether the officials of the SEBI/Finance Ministry would consult the president of the Stock Exchange with regard to the market situation. If they had done so, the SEBI/Finance Ministry officials are also equally responsible for encouraging the president to interfere with the surveillance department of the BSE. This too need to be probed.

Another major factor for the downfall in the equity prices is the fall in prices of technology stocks on the Nasdaq. That was indicative of a recession in the information technology industry in the U.S. Indian IT industry is today greatly dependent on the progress of the U.S. industry. Indian bourses were not ready to listen to any warnings.

The exuberance indicated on Budget day by a sharp rise in the Sensex was rather on the high side. There is actually nothing much in the Budget to promote savings. On the contrary, savings have been discouraged by a drop in interest rates.

Defaults by brokers, particularly at the Calcutta Stock Exchange, had a major role in the crisis. There is a crisis of confidence in the stock market today, as it was the case in the aftermath of 1992 Securities Scam, with ordinary investors running away from the market.

It is now very doubtful whether demutualisation or corporatisation of broker-driven exchanges is the answer. The experience of some of the stock exchanges like the London Stock Exchange, the Australian Stock Exchange, the Nasdaq, etc. is to be fully ascertained. Assuming that the brokers are kept away from the management of stock exchanges, confining their role only to their trading rights, what is the guarantee that a new management will act in an objective manner.

There has been a flow of money from banks to capital market in recent months. Private sector banks are prominent among them, including the Global Trust Bank (GTB). However, a reversal of banks' exposure to capital market recommended by the RBI-SEBI committee in September last year is not a solution. What is essential is that the banks should have expertise in judging the risk of the business as well as the organisational ability to administer such schemes.

Moreover, the prima facie evidence in price rigging of GTB shares raises doubts over the regulators' surveillance mechanism. The RBI was aware of some unusual price movements in GTB share prices in November last year itself and the SEBI took another three months to inform the RBI that it had found evidence of price rigging in GTB share prices. The true measure of regulatory competence is the ability of the regulators to take quick corrective action. Further, the GTB's loan to Mr. Parekh without collateral is another issue that raises questions on the RBI's role as a regulator. Regulation and supervision and the quality of on and off-site supervision of the RBI and the SEBI should be strengthened and they should be delinked from the Finance Ministry with more autonomy and powers.

The regulator should continuously monitor the investment pattern so that any undue change in a particular stream, like the broker position, could be identified and immediate investigation conducted. The Government also should strengthen the investment institutions to facilitate long-term investments. Flow of money to the capital market from the lending institutions should be more transparent so that undue concentration of lending on a particular scrip is avoided.

The financial crisis in Asia in 1997 has led to a fundamental re- think about the way in which financial markets should be governed. While other Asian countries are converging towards an international set of governance best practices, India is still lagging behind in terms of quality and speed of implementation. In a globalised economy, countries which fail to base the financial liberalisation on strengthened economic policies and institutional structures are bound to suffer financial crisis.

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