People's Democracy

Curbing Speculation Key To Ending

Wild Stock Market Swings

 Chittaranjan Alva

THE evidence, on balance, suggests that speculation or day trading is the major driver in the stock markets. This is amply borne out by the figures of deliverable trades to total trades published every day on the web site of the National Stock Exchange (NSE) (nse-india.com). In the case of the highest 50 capitalised companies on the NSE speculation or day trades sometimes add up to as much as 70 per cent of an individual stock’s total trades. This is the real size of the speculative bubble.

The mechanism of speculation is simple. When prices are rising operators buy stocks only to sell them later in the day for profit. This is known as long purchases. When prices are falling, the same operators sell stocks only to re-purchase them on the same day, again for profit. This is known as short selling. In either case, money does not change hands when purchases are made nor does delivery of shares take place when sales are effected. Such trading is also referred to as naked trading.

VOLATILITY IN THE STOCK MARKETS

There is one simple remedy to ending the raging see-saw volatility in the stock markets. And that is to ban all forms of naked trading. In other words, every single trade should compulsorily end in physical delivery of shares and payment.

This can be easily done through a mere circular to stockbrokers by the Securities and Exchange Board of India (SEBI), which is supposed to act as the watch-dog body over the stock markets, but is usually never found at its post when major scams are underway. And if SEBI is not prepared to ban naked trading, then the political leadership must intervene in the matter. The finance ministry is more than adequately armed to do so, and it would be in the fitness of things if it did so since the new government’s commitment is to equitable opportunity and growth. Operators running amok, forming cartels and destablising the markets for quick profit – and very often doing so with public money -- is hardly the way forward to clean and equitable opportunity and growth.

It is not being argued here that banning naked trading will automatically put an end to all volatility. External factors such as oil price shocks or wars play their own role; so will massive infusions of hot money when it is perceived abroad that there is a killing to be made in the Indian stock markets. But volatility based on manipulation will drastically come down, although even then operators will strive to circumvent barriers and continue in their bad ways. That’s where an alert SEBI will be most needed to discharge its ordinary duty.

As for curbing the menace of hot money, it is altogether feasible, provided there is the requisite political will, to impose a lock-in period of, say, a year or so before it is allowed to leave the country again. If this is done then FIIs and hedge funds will think twice before entering India’s shores as marauders.

In fact, operators should be strictly consigned to the derivatives market which is a pure betting market – just like the race courses. The derivatives market is being allowed to expand in India by leaps and bounds. Not only is there futures trading in stocks, but futures trading in commodities has also been introduced. There is also talk of allowing futures trading in the foreign exchange market and in gold and silver. Thus there is adequate opportunity for speculators to satisfy their appetites in various forms of the futures markets.

But as matters stand today, operators in the stock markets often combine into a cartel to either push up or down the prices of individual or a group of stocks so that even greater profits can be extracted.  Everyone knows that this happens, and former divestment minister Arun Shourie himself asserted that such a cartel was at work when the price of ONGC shares was pushed down during the recent divestment exercise. Yet Arun Shourie eventually shied away from taking action against the cartel of bear operators whom he implied he knew but would not identify.

WEAK-KNEED APPROACH OF SEBI

The same weak-kneed approach has consistently been followed by SEBI. It has always demanded more powers and obtained them from the government. But all it does is to blow hot and cold after a scam has taken place. SEBI has virtually allowed one scam after another to flourish under its very nose -- the Harshad Mehta scam, the Ketan Parekh scam, the massive UTI scandal, this year’s insider trading operation by a Singapore-based mutual fund and, of course, the bear cartel pushing down the ONGC price, to name only a few big ones. After the May 17 stock market implosion, when the Sensex collapsed at one point by some 820 points, SEBI bravely announced an investigation of books of market participants, but since then has never opened its mouth even once to say how far the investigation has progressed, or what really happened on that day and who should be held responsible for that monumental scandal. Therefore, the time has come to make SEBI accountable for habitually never taking prompt action along with imposing severe penalties when misdemeanours take place. This is all the more necessary since very often-public money is roped in to pursue shady deals.

In this context, a well-known market commentator, Sucheta Dalal, has written: “All through the 1980s and 1990s, UTI acted as a market stabilisation fund, operating under the instructions of the finance ministry. Calls from the ministry were notorious for asking UTI to bail out industrialists who speculated in their own company shares on the stock markets and found themselves trapped; or, to help influential companies to place expensive equity and dubious debt with the Trust” (The Indian Express, June 7, 2004).

POTENTIAL FOR FRAUD

This highlights the important point that any discussion on the stock markets should not flounder on the fact whether public participation in the stock markets is small or not, but concentrate on the enormous potential for fraud.

As matters stand today, far from reducing the role of public financial institutions and banks in the stock markets, the tendency is to increase it. The BJP-led government had toyed with the idea of setting up a pension scheme, a part of whose corpus would be invested in the stock markets.  There even was a proposal considered by the BJP-led government to permit up to 20 per cent of public provident fund money to be invested in the stock markets. Had the BJP-led government returned to power, these proposals may well have turned into reality and one day led to the mother of all scams -- that is, playing the markets with workers’ savings and losing them.

Something akin to such a scam occurred in the United States during the stock market bubble of the 1990s.  Michael Hudson, a professor of economics at the   University of Missouri and sometime associate of the New School for Social Research, has squarely blamed employers and financial institutions for the diversion of workers’ savings to finance the information technology bubble on Wall Street during the 1990s.

He has said: “The bubble was fed largely by the ‘forced saving’ that was withheld from the paychecks of the employees. These ‘savers’ were not allowed to spend their savings in a discretionary way – for instance using it to buy their homes or pay down their mortgages or even to pay off their higher-interest credit card debt. The money that was withheld out of wages and salaries was set aside in pension and retirement plans managed either by their employer or large financial institutions…when the dust settled after the stock market downturn of 2000, the gains that people had thought they had made were exposed as largely illusory. They turned out to have been produced by fraud.”

IN THE SERVICE OF SPECULATION 

Today the LIC and UTI are major players in the stock markets, but there is hardly any public detailed audit available as to what their roles precisely are. A lot of secrecy is associated with the transactions of these institutions in the stock markets. In the case of LIC, if investing and making money in the stock markets is an end in itself, then why do LIC policies not give a higher yield?

 Currently banks and even some private financial institutions are allowed to loan money up to 60 per cent of the value of shares held by an individual or entity. This enables operators to deposit, for example, Rs one crore worth of shares as collateral with a bank or private financial institution and obtain Rs 60 lakh in loan to play the market virtually free of charge. Most of this money is re-ploughed into speculative day trading. One theory holds that on May 17 when the market collapse began, banks began to call back the margins lent against shares as collateral and this, in turn, further precipitated the downfall of the market on that day.

Therefore, the real problem to tackle is that the existing arrangements promote shady and speculative practices for private gain. The public financial institutions and banks have been brazenly put in the service of speculation. It is only when scams occur that the nation gets outraged at the extent of public money involved in private gain.

After the May 17 stock markets collapse there has been some talk of instituting a market stabilisation fund for intervention during wild volatility. Proposals doing the rounds envisage large contributions from the public financial institutions and perhaps banks for building the corpus of such a fund. Thus public money, again, is expected to eventually bail out the speculators.

But if wild volatility itself is curbed in the first place, most of the bad practices associated with speculation can be extinguished. For this it is necessary to tackle speculation at its roots. One way of doing this is to ensure that all trades culminate in compulsory delivery and payment.

CORRECTION

The web site at which data on deliverable trades as a percentage of total trades is available is nse-india.com and not sebi-india.com as was wrongly stated in the issue of May 17-23. The three main stock market web-sites are: nse-india.com; bse-india.com; and sebi-india.com.