People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 21

May 23, 2004

The Avoidable Stock Market Crash —

It’s Causes and Remedy


Chittaranjan Alva


The devastating Indian stock market crash of Black Monday, May the 17th, will go down in the history books as both a titanic calamity and an altogether avoidable event had a simple regulatory framework been put in place by the market-friendly BJP-led coalition government during its six years of misrule.


Attributed by the big press and TV channels to the statements on ending divestment in profitable public sector units made by the Communist Parties — which were in any case positions well known for years — the swift and precipitous fall is a classic example of how Foreign Institutional Investors (FIIs) and big operators will pounce on any opportunity to make quick profits, in this case astronomical profits extracted in a single day through short selling!




Could this carnage have been averted? The short answer is: Yes, it could have been avoided!


The Indian stock markets are perhaps the only place in the world where you can buy shares without having to put money on the table and sell shares you do not own. This extraordinary situation has facilitated rampant speculation by all sorts of operators – the indigenous variety, FIIs and even our own native financial institutions (FIs) as the massive UTI scandal of recent years has demonstrated.


To purchase shares without having to pay for them, and to sell shares without owning them is simply speculation, or day trading as it is now called in the era of globalisation. Speculation or day trading typically takes advantage of daily share price movements, very often which are set into motion in the first place by big operators. The idea is to buy shares when prices are rising (long) and sell exactly the same number of shares later in the day; or, if the market is falling, to sell shares first (short sell) and buy back the same quantity later in the day. In either case, the transaction is concluded on the same day (hence the term day trading) and the aim simply put is to maximise profits.


So, when the stock markets were made to collapse by a record 800-plus points on May 17 under the pretext that the Left is opposed to divestment, the profits reaped by short sellers were astronomical and incalculable.


Could this situation have been avoided. As aforesaid, the answer is yes. The electronic monitoring system in both the Bombay Stock Exchange and the bigger National Stock Exchange automatically stopped trading for half-an-hour when the two markets respectively collapsed by 10 percentage points. Thereafter when trading resumed and the markets fell further to another stipulated lower level, the electronic system automatically stopped all trading again for another two hours.


A similar situation had occurred on Tuesday, September 11, 2001, the day of the terrorist attacks in New York city. At the end of the day the stock exchange authorities of both the New York Stock Exchange and the heavily-weighted software exchange called NASDAQ suspended all trading for the remainder three working days during that fateful week to safeguard investor interests. So, advanced capitalism does know how to intervene "politically" in the markets when fundamental interests are in danger of violation by short sellers.




Unfortunately, both the Securities and Exchange Board of India (SEBI) and the outgoing BJP care-taker finance minister Jaswant Singh just slept through the carnage in the Indian markets on May 17. If they had shown the requisite political vigilance and will they could have intervened early during the disaster when it was apparent to the man on the street that a first class disaster had begun to unfold. They could have stopped all trading for the remainder of that fateful day and for the next few days as well to allow time for the hot-heads in the stock markets to understand that they cannot get away with highway robbery. But they did not, and thereby hangs another tale.


To compound the problem is another factor. SEBI rules permit day traders to take buy and sell positions up to ten times the amount of money they deposit with a broker. Thus an operator with just a Rs 1 crore deposit can, in fact, take positions up to Rs 10 crores at any single moment during the trading day. An operator can go on transacting long buy-sell or short sell-buy orders during the trading day several times over, so that by the end of the day the total transacted value of orders may well exceed even the liberal ten times limit on cash deposited. In fact, throughout the trading day this is, in fact, what operators do – pushing through transactions with fantasy money, but at the end of the day laughing all the way to the bank with profits in real money.


If one goes through the statistics of deliverable shares as a percentage of total shares transacted that is daily available on the SEBI web site ( the enormity of the day trading exercise hits you in the face. As illustrative examples we shall take only the 12 highest companies capitalised on the NSE on May 17. In the case of ONGC day trades (that is, shares traded but not purchased with cash) amounted to 51.23 per cent of all trades done; Reliance 64.36 per cent; Infosys 51.71 per cent; Wipro 50.95 per cent; Hindustan Lever 32.64 per cent; Bharti Tele 49.09 per cent; State Bank 76.60 per cent; ITC 27.79 per cent; Ranbaxy 33.24 per cent; ICICI Bank 28.95 per cent; HDFC 31.88 per cent; and Tata Motors 63.85 per cent.


If in these examples some percentages appear lower it is only because at the eleventh hour LIC and UTI were ordered by the finance ministry after Dr Manmohan Singh’s intervention with Jaswant Singh to commence buying to bolster the market in its dying moments on May 17. If this intervention by Dr Manmohan Singh had not taken place, Jaswant Singh and all his senior bureaucrats in the finance ministry would have just slept through the entire crisis and allowed it to baloon into an even greater disaster. That about sums up to which sections the BJP government’s commitment lies in the "India Shining" episode.


As opposed to day trading is investment. An investor who purchases shares has the statutory right to get possession of his shares within three working days (T+2 days, where T stands for transaction day). Just as he has the right to shares purchased by him, the investor also has the obligation to pay for the purchased shares. Thus a clear monetary transaction takes place between a buyer and seller (through the medium of the broker), as in any market place.




The remedy to preventing speculation in the market is to statutorily ordain that all trades done in the market must be actually paid for in cash when shares are once bought by purchasers. Similarly, sellers must compulsorily surrender shares when shares are sold by them. In this way, the menace of long trades in which day traders purchase shares without coughing up the money so as to sell them later in the day for profit, and short sales by which sales are effected without owning shares so that they can be bought back later in the day for profit can be eliminated.


A couple of years ago SEBI introduced an altogether new section in the NSE called the derivatives market. This is a purely speculative market where shares are bought in lots of a few hundreds or even a couple of thousands. In contrast to the cash market where even a single share can be bought and taken delivery of or a single share can be sold and delivered to the buyer, there is no provision of taking delivery of shares in the derivatives market. Thus purchase of lots is pure betting on which way the share price will go – up or down. Moreover, the derivatives cycle lasts for exactly one month at the end of which all transactions are either squared up by the participants or electronically by the exchange.


When there is already provision for speculation in the derivatives market, and SEBI has said it intends to gradually expand its scope from the current 50-odd shares in which trading now takes place, there is little justification to allow the kind of speculation or day trading in the cash section of the market in which genuine investors, small and big, decide to park their savings. It is these investors, particularly small investors looking for a little higher rate of return than what bank deposits grant them, that have been the most grievously hit by the stock market shocks generated since the announcement of the election results signaling the abject defeat of the communal-BJP led NDA government.