Sucheta Dalal :Transformation of the Indian Capital Market
Sucheta Dalal

Click here for FREE MEMBERSHIP to Moneylife Foundation which entitles you to:
• Access to information on investment issues

• Invitations to attend free workshops on financial literacy
• Grievance redressal


You are here: Home » What's New » Transformation of the Indian Capital Market
                       Previous           Next

Transformation of the Indian Capital Market  

December 13, 2005

Page 2

Given the speculative instincts that dominate market players in India NSCCL introduced some of the most stringent regulations for its members. The mechanism of upfront or initial margins was introduced by NSCCL right from day one in a different garb. Each member was given trading exposure limits (net in each stock and gross across all the securities)based on the deposits that the member placed with NSE plus NSCCL. To begin with the net exposure ratio was fixed at 10, meaning thereby that no member can have, at any point of time, an aggregate exposure of more that 10 times his deposits. If a member deposits say Rs 2 crores he can trade within an exposure limit of Rs. 20 crores. To track member positions NSCCL developed unique software which tracks each member’s aggregate trading exposure on real time basis. The software has the capability of not only informing the member his exposure position on a real time basis but also disconnect all his trading  terminals the moment he crosses the limit granted to him on the basis of the deposits made with NSE/NSCCL. The NSCCL has been making variations in the exposure ratio depending on the market conditions. Later NSE calculated security- wise margins based on the volatility to which different stocks are subject to. As of now it would be no exaggeration that India has one of the most sophisticated system implement a scientific margining mechanism but that it is one of the few countries that has built strong capabilities to deny trading connectivity to members that exceed their exposure limits on a real time basis.


When NSCCL introduced the concept settlement guarantee fund for smoothly managing the settlements there was lot of misunderstanding about the concept of settlement guarantee itself. In real life situations it is very rare that in each settlement all the pay-ins are made fully by the members. Temporary shortages of either funds or securities invariably happen for various genuine reasons, given the fact that members/investors trade on NSE from nearly 400 places across the country. For example, a member may find that his client could not remit funds in time for the member to complete the pay-in before the predetermined time. In some cases investors may not able to give delivery of shares to the members in time if the members maintain their depository account with some other depository participant. It is also possible that client of a broker or the broker himself has traded excessively and is not in a position to honour his obligations to the clearing corporation. In this context it should be noted that just because all the pay-ins have not come forth the settlement should be aborted. In all such cases of shortages the NSCCL which acts as the central counter-party for the whole settlement process steps in and completes the settlement. If there is a shortage of funds the settlement guarantee fund is used to complete settlement. If there are security shortages NSCCL procures the shares by buying them through an auction or borrowing the securities as recently permitted by SEBI. Later the NSCCL recovers the dues from the members who are short in deliveries and also levies fines for not having made the required pay-in in time. It is only when the concerned member fails to pay up his dues to the NSCCL within the time frame stipulated by it that the procedure for declaring him defaulter kicks in.


In the beginning when this system was introduced there was a great deal of misunderstanding about it. Some even unfairly and maliciously accused NSCCL as encouraging speculation by funding settlement shortages. They ignored the fact that before BSE put up its own form of settlement guarantee arrangement it had to shut down the exchange during the mid-1990s for three consecutive days to resolve the problems caused settlement default by a member of a relatively small amount. Settlement guarantee fund helps to fund settlement shortages as a bridging mechanism so that the settlement goes though smoothly and there are no cascading defaults. During its existence so far NSCCL has been able to manage all the settlements on time with the help of the settlement guarantee fund even when there were large pay-in shortfalls. In most of these cases NSCCL has been able to recover later the pay-in shortfalls from the members. In all those cases where members failed to meet their obligations to the NSCCL, even after they were given reasonable time to make good their shortfalls, such members were declared as defaulters and the shortfalls were met out of the incomes NSCCL earns by way of interest on settlement guarantee fund as also the small fees it collects from the members as settlement charges. By now the concepts of the settlement guarantee fund and guaranteed settlements have become accepted folklore in our capital markets. But it should not be forgotten that when we introduced them for the first time in the country, we had to face lot of malicious criticism from the market players and hostility from unexpected quarters. Some market players even went to the extent of spreading falsehood that IDBI was continually funding NSE’s settlement shortages as also losses incurred by NSCCL just because IDBI was the main promoter of NSE.


NSE: Third largest exchange


In terms of the number of number of transactions NSE today is ranked as the third largest exchange in the world, next only to NASDAQ and NYSE. How did NSE come to occupy this position in its short history of decade. It has also been able to establish another major landmark. It is the first stock exchange in the world to cross the turnover of an already well entrenched stock exchange in its own country, viz., BSE in a very short period of one year. It is worth noting in this context that the initial run for the NSE was not at all that smooth. During first few months of its existence its trading turnover was quite modest, often less than Rs. 10 crores a day. It appears that the investors as also our members were testing our systems and our management capabilities. When they saw that all the settlements were being completed absolutely in time without any hitches they started developing confidence in us. As our rules and regulations were absolutely transparent and once investors started seeing prices and quantities in different stocks on a real time basis at all places where our terminals were located they came to recognise a major difference between NSE and all other exchanges. As NSE volumes started growing the prices reflected on its screen became a benchmark for all other exchanges including BSE. It did not require much time for NSE to establish its leadership in the market. Another interesting thing that is worth noting is the composition of its investor class when it emerged as the largest stock exchange of the country. At that time more than 90% of the value of trading was accounted for by non-institutional or retail investors. Strangely even most of the promoters of NSE were not trading on NSE. That is why I consider that institutional investors are less market savvy and laggards as compared to retail investors. Although the institutional investors’ holdings have grown quite rapidly during the last decade the retail investors continue to be the backbone of our equity markets. Given the fact NSE enjoys maximum trust of retail investor community it will continue to grow both in terms of trading volumes as also in terms of market share.


Sizable institutional orders are still said to be going to BSE for a very strange reason. Since its order book position at most of the time during the trading hours is reported to be thin institutions prefer to execute their negotiated deals on the BSE. As per SEBI rules the trades have to be matched on the trading screen of an exchange. If the institutions place their orders on the NSE’s trading screen they run the risk of their orders getting matched with other orders since there is considerable order depth on the NSE screen during almost the entire trading hours. Therefore for concluding 1-2-3 type of deals the institutional investors prefer BSE screen in view of its shallow order book position. Indirectly this is a tribute to the NSE as those who trade on it can end up having more efficient order execution. 


Depository with dematerialisation


As NSE spread across the country it faced serious problems related to the paper-based settlement system. The first set of problems related to transport of share certificates to the central clearing location in Mumbai. Since NSE decided to shorten the settlement period it introduced a weekly settlement system as against BSE’s fortnightly settlement. Shortening of the settlement period along with the responsibility of clearing settlement of the net obligations during the next week put excessive burden on NSE. The pay-ins of securities from all over the country at Mumbai and thereafter re-dispatch of pay-outs at all the relevant locations in a week’s time created lot of difficulties for its members. NSE therefore decided to offer a helping hand to its members. It made arrangements to receive all the pay-ins at four major metros, viz., Mumbai, Delhi, Kolkata, and Chennai  and also make payouts from these four metros. At its own expense NSE used to ship by air all the securities pay-ins from the other metros to the central location in Mumbai and reship by air the pay-outs to the other metros. On many occasions NSE had to airship share certificates weighing more than four tonnes a week each way at its own expense. The paper based system posed other far more serious problems. Several anti-social elements tried to take advantage of the system by introducing fake and fraudulent securities and transfer forms that accompanied them. To deal with problem of fake certificates NSE, with the assistance registrars and transfer agents of the companies, launched a system of scrutiny of the documents before they are accepted as pay-ins. Despite all this NSCCL as also several members suffered loss due to the massive nature of this problem.


 NSE therefore took in serious earnest the task of setting up a depository where ownership records would be maintained in the dematerialised form. The speed with which this task was also implemented could be noted from the fact that the depository went live in November 1996, just two years after NSE went live in November 1994. It was a great encouragement and relief for us when Mr Bhave agreed to take up the responsibility as the first MD and CEO of the depository in the early part of 1996. He has done a wonderful job at the depository and taken it to great heights. NSDL therefore continues to be the most preferred depository of the country by the investor community. In this context it is worth remembering that despite the obvious advantages of a depository there were some people who were not in favour of the depository. These were the people who could benefit from badla trading in paper-based environment. The true motives of some of these people got exposed during the 1998 stock market debacle when it was found that physical share certificates were being misused in the badla trading. If depository movement has become a resounding success in India in such a short period of time it is a tribute to both the Government and the SEBI for consciously pushing the capital market players in that direction. The Indian depository is unique in the world in one respect; it is, perhaps, the only depository to have full data on investor holdings, which gets updated continually. The investors are therefore better protected from problems that may arise due to intentional or unintentional activities of the depository participants which are in the investors’ interest. The success of a dematerialised depository has also helped to usher in an era of rolling settlement. In a period of less than four years the Indian capital markets could make a transition from a weekly account period settlement first to T+5 settlement, then to T+3 settlement and finally to T+2 settlement. Indian is one of the very few countries globally to have adopted T+2 settlement system. It would have been simply impossible to think of rolling settlement if depository movement had not caught on in such a short period of time. India is one of the very few countries where the depository movement has become such market-wide success.


Futures & Options launched


Despite the advice to the contrary even from many of our well wishers we decided not to introduce badla trading system on the NSE. Some had favoured NSE introducing badla trading as they felt that we would be able to manage it more efficiently and in a transparent fashion. The main reason why we did not favour badla trading is that it is a hybrid product which muddies up the price discovery process as badla is a mix of the cash and the futures market. Badla grew rapidly in the Indian market after the forward trading was banned in the 1960s because of the excessive speculation that it was leading to. Badla provided an escape route to the active market players; it gained in popularity with speculators as also many financiers who wanted to deploy their funds in a profitable way. The badla trading system also became a conduit for deployment of unaccounted money for traders in many areas including diamond trading. Authorities had periodically expressed their unhappiness with several unhealthy practices adopted in badla trading. Hence it was banned a number of times when the markets got excessively heated up. During the mid-1990s SEBI lifted its ban by stipulating some stringent conditions on badla trading. BSE found that it would take considerable effort on its part to develop software that could ensure that SEBI conditionalities were met. When BSE could not introduce modified badla quickly some of the more disciplined and professional minded ardent supporters of badla approached me with a request to introduce modified badla on NSE because, according to them, NSE would be quick and more efficient in introducing the modified badla, given its proven capabilities to develop good software. But since NSE was not keen to compete with BSE for its own sake or to capture larger market share by adopting any means I was not tempted to accept the proposal. It was my strong conviction that badla might have served some purpose at a time when the Government had banned abruptly forward trading. But it had outlived its utility and should therefore be phased out and in its place we should have futures and options. Because of this view of mine I had become a much disliked person among the badla supporters as also some of the important people in official circles. Right from day one of NSE I was keen that India should graduate into the globally accepted most efficient form of futures trading viz., options and futures; hence our efforts were, at that time, concentrated on getting SEBI approval for the futures and options. Being a totally new product it did take us quite some time to get the futures trading duly approved. Major part of the difficulty that we faced was on account of the powerful badla lobby which strongly opposed introduction of futures in the Indian markets. The main worry of the badla lobby was that, once futures were introduced in India, badla would become less attractive.


After great deal of efforts, futures were allowed to be introduced. However, BSE managed to score over NSE by launching futures one day prior to that of NSE. But that has not help BSE in any way as could be noted from the fact that futures have not taken off at BSE. As of today more than 99% of the futures trading in the country happens to be on the NSE. One need not put in great efforts to find out as to why BSE has lost to NSE in the futures game. The reason for this is simple. When NSE was concentrating its efforts on building its in-house expertise, developing the trading and settlement software, and spread of the message of futures countrywide through large number of investor seminars BSE was emotionally pleading the case of badla even in foreign countries. As a result, it lost a great deal in terms of getting seriously prepared for the introduction of a relatively more complex options and futures trading. Once having lost the lead in this area it has become more difficult for BSE to attract investors to its futures segment. During 2000-01 the market witnessed exceedingly high speculative activity on the exchanges, aided by badla with diluted standards and inter-exchange position shifting. This led to a market crash forcing Government to ban badla and announcing introduction of rolling settlements. My worst fears about the highly risky nature of badla trading were proved to be correct and our decision not to introduce it at any cost also proved to be the right one.   


Risks of stock futures


The original plan of bringing futures to the country in place of badla was to introduce index futures, index options and stock options. The SEBI Committee that went into the whole issue of equity based futures was not in favour of stock futures which are, however, currently being traded on the NSE. In fact, all over the world the widely accepted futures products are the index futures, index options and stock options. In most of the countries wherever equity futures are traded the individual stock futures either find any place or that even if they are grudgingly allowed not much trade takes place in them. Most of the market players either do not find individual stock futures to be useful products or that they consider them….and very rightly so… highly risky products.


The basic purpose which the equity futures are supposed to serve is to provide a mechanism to investors to hedge their risks arising from unanticipated market movements. It is universally accepted that index futures serve this objective of protecting investors from market risks eminently by paying a small cost in the form of margins paid to the exchanges. Let me briefly explain what this means. The price of a stock at any point of time reflects influence of two factors. The first set of factors relate essentially to the performance of the company itself. For example, if you have invested your money in say a cement company, the price of its shares depend on the profitability of the cement industry in general, relative locational advantages/disadvantages of the production facility of the company, type of production technology, quality of its management, etc. The other set of factors that influence the price of the equity shares of that cement company would depend on the state of the capital market itself. Even if there is no change in the factors that influence working of the particular cement company, prices of its share will go up or down depending on the bearish or bullish conditions in the market. When an investor invests in a company after making detailed study about the company he can be reasonably sure about its worth and the price he should pay as of today. But it is not possible for the investor to predict as to what will happen to its price say after three months if the market conditions change. To protect investors against such risks which are associated with the future market trends index futures have been devised. If an investor is interested in only specific stocks he can as well buy options contracts in such stocks which the option writers provide. In fact the stock options are the safest for an individual since his upside risk of buying an option is limited to the extent of the margin money paid for buying stock options. In the case of stock futures the risk can be very high if the market moves in the opposite direction by a large measure.


The world over, the stock futures are not favoured in view of the risks they pose to the investors as also to the markets. Futures in individual stocks are considered to be highly risky primarily because they can be manipulated by unscrupulous speculators. A group of large speculators can come together and manipulate the future prices by acting in a concerted fashion. Since a trader in futures has to shell out only margin amounts and not the full price of the value of the contract, leveraging becomes easy. In other words, amounts required to manipulate futures prices of an individual stock would not be very large if a group of speculators can act in concert to manipulate its market price. The same cannot be said about index futures. For example, the NSE’s main stock index viz., NIFTY has a huge market capitalisation of around Rs 12 lakh crores. It is therefore not as easy to manipulate NIFTY as individual stocks. Recently there has been some discussion in the newspapers about the manipulations of NIFTY index by some unscrupulous speculators. The mechanism adopted by such manipulators is relatively simple. They pick up a share of a company like HLL which has a large market capitalisation but with relatively smaller floating stock for manipulating Nifty-50. After the introduction of individual stock futures it has become much easier to manipulate shares like HLL as one needs much less margin money to be deposited with the exchange for buying futures in HLL. If there were to be no futures in individual stocks speculators would need much larger amounts to take delivery of stocks and hold them for manipulating share prices. Thus we have introduced a futures trading systems which it much easier for market players not only to manipulate prices of individual stocks but also the indices on which futures contracts are written.


Most of the countries that have introduced equity futures have preferred to introduce index futures, index options and individual stock options. Very few countries have taken the risk of introducing individual stock futures. Even in those countries where the individual stock futures have been introduced the relative trading volumes are highly modest. Italian stock exchange which ranks next only to NSE in terms of value of traded contracts in individual stock futures accounts for only 25% of NSE’s volume. But when it comes to value of contracts in index futures the volume of Italian exchange is nearly twice that of NSE. This is indicative of the fact that individual stock futures are not considered as safe as index futures even in the country in which such futures products are traded in noticeable volumes. All the major futures exchanges of the world in the US or Europe consider that individual stock futures is a highly unsafe product but also that it does not serve any justifiable purpose. Despite the obvious risks that individual stock futures pose to the safety and integrity of the capital market they have been introduced in the country.


Many in this audience may recall the heated discussion we used to have until 2001 on the possible risks that badla trading posed to our capital market. Surprisingly, several influential policy makers both in Mumbai and Delhi were its strong supporters of badla and sincerely believed that it served a useful purpose. I was one among the hopeless minority who strongly believed that we should ban badla and in its place introduce the relatively safe futures products. I held this view even before the idea of NSE came on the horizon. Many people felt that my opposition to badla was doctrinaire one and not based on logical ground. But I was proved by the stock exchange crisis of 2000-01 which forced the GoI to ban badla and also introduce rolling settlement in 2001.


I continue to hold a view that it was not a wise thing for us to have introduced individual stock futures in our country. I am fully conscious that I am in a hopeless minority to hold such a view. All those who had mourned the death of badla are now very happy that a similar product is now available to them to play their games in the equity markets. Some prominent brokers hold the opinion that the void created by ban of badla has been filled up through an equally risky product like individual stock futures.  I sincerely believe that one day we are going to face a market crisis because of the unbridled growth of the trading volume in individual stock futures. Of the daily total trading volume of all the futures products the individual stock futures alone account for over 60%. Further the daily trading volume of the individual stock futures is on an average more than double of the trading volume of cash market. These two indicators are adequate to bring out the preponderant influence of the individual stock futures on what happens in the cash market for equities.


Shortening of settlement period


Most of you remember that before setting up of NSE the settlement system followed by BSE the exchange which accounted for nearly two-thirds of the trading volume of all the exchanges of the country until 1994…was an account period cycle of trading for a fortnight and settling the net obligations after a period of 15 days. Thus if somebody traded on the first day of the trading cycle could get his funds or securities almost after a month. Frequently this period used to get extended to almost six to eight weeks if there was hectic activity in the market forcing the exchange authorities to club several trading cycles. After NSE started operating it reduced the cycle to one week of trading and settling the net obligations a week thereafter. But since early part of this year we are all in a rolling settlement era. To begin with a T+5 cycle was introduced meaning thereby that each day’ trades are settled five days thereafter. Introduction of the rolling settlement meant India entering into the global league of more efficient markets. This prompted the authorities to push this reform further to shorten the settlement cycle further to T+3 settlement mode. Later, with a view to score over even the developed countries in shortening the settlement cycle the cycle was reduced further to T+2 mode. In this context it should be noted that the major developed country markets in Europe and America have been toying for the last several years with the idea of shortening their settlement cycle from the current T+3 mode.  But they have refrained from the temptation of reducing the cycle to leas than T+3 mode for the simple reason that the disadvantages arising from shortening the settlement cycle far outweigh the gains. All that the shortening of the settlement cycle is means getting funds or securities one day earlier. But the hassles of managing such a short settlement cycle are far too many besides the risk of several players not being in a position to complete their pay-in of securities and funds in time to complete T+2 settlement.


In India we face many problems due to various stages of computerisation and risk management practices of several market players. It is simply not a question of availability or otherwise of RTGS at all places. Most of our banks do not have efficient EFT facilities which enable banks to move funds from one branch where a customer is located to the other branch which interacts with the exchange clearing corporation. Secondly, even though currently there is depository mode of delivery many investors find it too inconvenient to make their delivery in time for the settlement. Hence many investors either give power of attorney (POA) to their broker or sign delivery slips well in advance and keep them with their brokers. All of your must be reading the horror stories that are coming to light where the brokers have cheated their investors. I do not want to dilate on this point too much as all of you are already aware of the risks that been posed to the investors as a result of shortening of the settlement cycle to T+2. One therefore often gets tempted to ask as what the investors has gained from shortening the settlement cycle except providing an opportunity to some people to claim that India is ahead of even the developed countries in terms of shorter settlement cycles.


Problems of participatory notes


With our stock markets passing through an unprecedented boom period the problems posed by the so called participatory notes (PNs) are being discussed in several responsible quarters. Some of the FIIs which are registered with SEBI and are permitted to invest in our equity markets float funds mobilised by then though the PNs which are subscribed by other eligible investors (other than persons of Indian origin and overseas corporate bodies owned by Indians). When the FIIs invest funds mobilised through PNs for investing in the Indian equity markets they have to give a written undertaking that they have not mobilised funds form non-eligible entities. Frankly, the current regulations governing the PNs are not satisfactory enough to ensure that absolutely right type funds are getting into our markets. Many people feel that the colour of money cannot correctly be known when it is flowing through the PNs. The worry about the PNs is that the current boom is largely fuelled by the FII money, bulk of which is flowing through the PNs. The vulnerability of the markets to manipulations increases when it is difficult to know the source of money that fuels activity in the market. Since large amount of money has flowed into our equity markets through the PNs it is difficult to nay take corrective action that will lead to sudden outflow of money. The risks of steep market fall are difficult to face. It is a big dilemma facing the policy makers.


Short selling & securities lending


Currently SEBI is seriously examining the desirability of allowing short selling by the institutions which cannot undertake other than delivery based trades. The idea is provide a level playing field to the institutions so that they can also freely trade in the market as other market players. This policy is also expected to be accompanied by two other measures. When institutions are allowed to sell short they will also be subjected to the same margining system as others who are permitted do short selling. Secondly, to facilitate short selling a scheme for lending and borrowing of securities would be introduced. Somebody who sells short can complete the settlement by borrowing the securities from willing lenders and delivering them at the pay-in time to the clearing corporation. The borrower of securities can them buy from the market at an appropriate time to return borrowed securities to the lender. The argument in favour of short selling is that it allows market players to take view on security prices. If a market player feels that current prices of a security are too high he can sell the borrowed securities and cover his position at a later day when the prices are expected to fall.


In theory, the facility of short selling looks attractive since it may provide opportunities for intelligent players to introduce corrective market forces. But often the reality could be different as experienced by Hong Kong a couple of years ago. Several large players took advantage of the short selling facility together with the lending and borrowing facility to beat down prices. Large speculators can indulge in heavy short selling to push down the prices steeply and cover their position at a later date at much lower prices. Such player can reap huge profits at the cost of other investors and market stability. One is really not sure whether it is desirable to introduce all such facilities which have the potential for destabilising the markets without any compensatory benefits.


Is the boom lasting?


A large number of those who are deeply interested in the equity markets are very anxious to know whether the current boom will last and how far the market will rise further. Frankly, it would be very difficult for any body to make any reliable forecast on a subject like this. If anyone knew the right answer he could make huge amount of money. So do not believe anyone of those who are cocksure that the market is moving in any direction. If some are giving you such forecast they are trying to fool you. If however they are a part of the powerful manipulator group they would be perhaps be right people to tell you in which direction the market will move. But you can be certain that such manipulators will never tell you the truth because their attempts would be to fool the market so that they can make money. If they want to buy they would like tell that this is the best to time sell so that they can when the market goes down as a result of large sales.


Without trying to make any hazardous guess I would like to provide some tools with the help of which you should yourself try to analyse market trends and likely direction in which the market may move in the near future. The first question that comes to anyone’s mind is how to judge as to what is the right or justifiable level of the market and when can it be said to be at an artificially high level or a depressed level? If you have the correct answer to such a question you can judge as to whether the market has the potential to go up or down. There two types approaches to this problems. There is one set of people who can be said to be rationalists who believe that fundamentals of a company should be used for assessing whether market price of a company’s share is at a reasonably right level. A company with high level of earnings and prospect of future growth always commands attention of investors who are willing to pay good price to keep it in their portfolio. Even though a company is not earning high level of profits its share will also command a premium if there is a fair chance that its future earnings will be at high. Certain industries at particular times are considered as growth industries and companies belonging to these industries will be considered as valuable. Companies belonging to stagnant industries will be valued cheaply even though are highly profitable. There is considerable strength in this line of reasoning. Since investors buy shares from return considerations they would attach importance to current as well as potential future growth in earnings. Company shares are not pieces art or culture, which are valued on totally different considerations. Despite all the strength in this logic it should be noted that fundamentals do not help much in deciding the right price of a share at any pint of time. Equity markets are subject to cycles of boom and depression and the same company’s shares with unchanged earning conditions will be priced differently at different times. Ina booming market even relatively dud shares command high prices. This phenomenon could be better noted from the fact that the levels of P/E ratios of individual shares as also of stock indexes are very high boom conditions and are much lower under depressed market conditions. Boom conditions are often victims of irrational exuberance while in depressed market condition victims of irrational gloom. Thus fundamental analysis does not help to determine prices of shares at all time and under all market conditions. All that the fundamental analysis tells us is whether relative price levels of different shares are rationally determined. If you agree with this logic you will agree that it is difficult to tell whether as of today the market has priced itself correctly when the Sensex is around 8800 or Nifty around 2670. Nobody can tell you correctly whether market has potential to go up further or whether the Sensex will cross 10,000 by March 2006. If somebody predicts that market has overpriced itself and that in the next couple of months Sensex will fall below 7000 level you have no valid justification to disbelieve it.


My next proposition is that markets are deeply influenced by sentiments and herd instincts rather than logic. When large number of market players expect that market is likely to fall all of most of them will make attempts to exit the market as hastily as possible. Often there is an attempt to exit hastily and the situation is similar to that of a stampede the when there is avoidable suffering and loss. Each market player plans to exit as early as possible so that he exits when the prices have not fallen too much. When a large number of market players hasten to exit the market prices fall fast and steeply. Another interesting feature of market behaviour is that the responses of market players to certain developments are often disproportionate and excessive. In a relatively depressed market even a less consequential bad news leads a large fall in prices. Because of the herd instinct of the market players, price movements often tend to get exaggerated. My suggestion to all of you is not to treat market as a rational organism. 


One more aspect most of the investors to keep in mind is that, most of the time, markets are influenced, although in varying proportions, by market players who tend profit from the mistakes of uninitiated and gullible investors. A large number of investors who buy/sell on the basis of half-baked reports/studies tend to be big losers. Every boom sooner or later flattens out and large number of investors who hold on to their investments with a greed to profit from much higher prices end up as big losers. Most of such investors may not return to the market in the next boom. But like moths in every rainy season a new generation of moths get attracted to the markets. Hence the cycles of boom and burst recur. Investors who do not have stomachs to digest losses from market collapses or do not have the expertise to tread carefully to protect themselves from the furies of bulls and bears should not enter the wonderland of equity markets.            


I think I have rambled at length during the last 45 minutes or so. I am sure you will be in a mood to forgive me if you kindly remember the fact that it is difficult to avoid temptation for rambling when one is dealing with a subject like equity markets which are so volatile and influence life of millions of investors who spend so much time talking about them passionately.


Concluding remarks


Let me conclude my talk telling you something more about NSE and how some, otherwise well informed people, try to belittle the tremendous transformation that NSE has brought about in so far as the equity markets are concerned.  I recall listening to the talk of a capital market expert from the academic world about the reforms that got introduced in the Indian capital market after NSE was set up. I am not sure as to what was his intention in belittling all that NSE had done in a relatively short period of time. The main thrust of his argument was that it was easy to modernise any capital market if you have access to adequate financial resources to put up powerful computers with state-of-the-art software and good communication system to establish links among the brokers, the stock exchange and the investor community. He was also arguing that clearing and settlement efficiency and risk management capabilities of a stock exchange are all dependent on deployment of efficient software and systems. He gave hardly any credit to the quality of management of an exchange or to put it figuratively, the men behind the machines. If you go along with the argument of this expert you would be hard put to explain as to why BSE could not do, in the first instance, all that NSE was able to do. BSE was not short of financial resources; it had all the means to put up the most powerful computers, acquire the necessary software, and communication systems. If BSE had the will to reform itself there would have been no need to set up NSE. Strangely, even today when we hear discussion on the Indian capital markets we do not hear much about the importance of the motivations of men that are in charge of exchange management. Until the arrival of NSE on the scene the reforms were delayed mainly because of the absence of desire or drive on the part of the men who have the means and authority to bring about the required changes with single-mindedness of purpose.



-- Sucheta Dalal