Sucheta Dalal :Sensex Seesaw (1 Feb)
Sucheta Dalal

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Sensex Seesaw (1 Feb)  

What’s taking the stock market to never-before highs before it plunges to the depths again? Sucheta Dalal tries to make sense of the Sensex at a time of unusual volatility

HAVING rushed through the Rs 250-crore ‘India Shining’ campaign as soon as the November election process ended, the NDA government may now discover there is nothing like wilting stock indices to kill the ‘‘feel good’’ factor.

On January 1, ecstatic brokers and investors, fattened on a 150 per cent annualised rise in the Sensex between May and December 2003, were looking forward to a year of booming stock prices built on huge foreign portfolio investment. At the end of the month, it is a different story.

At a time when money was supposed to have flown in torrents into the capital market, stock prices have hardly budged. And instead of confidence, there is diffidence, confusion, fear and desperate attempts to explain why stock prices are refusing to maintain a shining trajectory.

This year began with worries about whether the market would be able to absorb the large portfolio investment that was projected to flow into India. Foreign institutional investors (FIIs) had pumped in $7 billion into Indian stocks in 2003. They were supposed to double their investment in 2004. There were fears of a speculative bubble if this new money were to chase scarce investment opportunities. Investment bankers were urging the government to hasten the disinvestment of PSUs in order to soak up the inflow of dollars and expand the basket of good stock in the market.

Not any more.

Suddently leading investment bankers are struggling to explain the viciously volatile market behaviour. It began on January 6, but the sharp increase in volatility was especially obvious after the finance minister announced his ‘mini-budget’ on January 9.

Normally, the market should have ended on a euphoric new high. Instead the benchmark Bombay Stock Exchange Sensex touched an all-time high of 6249.60, dropped to a low of 6096.68 on the same day and finally closed at a sedate 6119.59 — an intra-day movement of 152 points.

That was just the beginning. Since then, it has been day after day of fierce plunges and sharp upward peaks that have exerted a downward pressure on prices in January, ignoring extremely significant bullish developments.

After all, the rupee is stronger, Fitch and Moody’s have upgraded India’s credit rating, most leading companies have announced excellent corporate results and the mini-Exim Policy has loosened the import regime and reduced duties. All this is in addition to Jaswant Singh’s ‘mini-budget’.

But the market remains unimpressed.

Although the overall sentiment continues to remain bullish, the inexplicable daily mood swings are forcing brokers, investment bankers and fund managers to find a variety of excuses for the market’s strange behaviour.

For several days, the volatility was attributed to the alleged confusion over the status of Participatory Notes (PN). These are derivative instruments issued to overseas investors, who are not eligible to invest in the market and represent a basket of underlying securities.

PNs issued to unregulated entities are considered a problem because they provide an entry to hot money, Indian black money stashed abroad, and international hedge funds whose investment strategy of swooping in on market asymmetry to make quick money sometimes tends to destabilise markets.

However, the PN issue resolved itself a few days ago with the Securities and Exchange Board of India (SEBI) choosing not to impose any significant curbs on their investment. Although a section of the business media exaggerated the PN effect, FII operations over the past fortnight do not indicate any serious panic over this issue.

In fact, FIIs have been net buyers of equity on most days of the past fortnight (see graphic) irrespective of whether the Sensex had risen or fallen. But the impact of their huge buying and selling operations in inducing market volatility probably needs further study.

Especially since SEBI’s permission for PNs to be issued to regulated entities from around the world still leaves it clueless about their beneficial ownership and exposes the market to the dangers of fickle hedge fund investment.

Another explanation for the steep intra-day spikes was that large operators were forced to unwind leveraged positions to make margin payments.

Leveraged trading on the stock market is usually funded with a margin payment of 25 to 40 per cent of the ruling market price. However, when prices fall sharply, jittery financiers ask borrowers to top up margin payments with additional funds or to reduce their exposure by selling a part of their holding.

The sharper the fall in prices, the more indiscriminate are the sales meant for margin payments.

Anecdotal evidence suggests that such sales indeed depressed prices even further on bad days. But that still does not explain the schizophrenic ‘‘up one hour, down the next’’ kind of movement.

In normal situations, a 70 to 80 point movement of the Sensex is considered significant. But since January 6, the intra-day peak and dip of the Sensex have been a frightening 200 points-plus almost everyday. And on January 22, when the Sensex fell sharply to 5,593, the intra-day movement was a phenomenal 285 points (see graphic).

Traders have often attributed the high volatility to FII activity in the derivatives segment. They claimed that FIIs were not merely hedging off their cash market investments against the derivatives trades, but were going short in the futures market, thereby causing turbulence in the cash segment as well.

While it is indeed true that FIIs have been short on the derivatives segment, the regulators have not found evidence of manipulation.

Yet if there is one factor that differentiates the present bull run from the past, it is the explosive growth of the derivatives market.

Even in the bull run of 2000, the National Stock Exchange (NSE) had generated trading volumes of over Rs 5,000 crore per day in the cash market, and for a while the combined turnover of the NSE and the BSE had touched Rs 10,000 crore.

Take a look at trading volumes. NSE’s daily turnover in the cash market is over Rs 5,000 crore, but volumes in the derivatives segment have been thrice as high at an incredible Rs 15,000 crore plus everyday.

These volumes reflect higher activity by investors, especially day traders, who are forced to operate in shorter time segments. But do these high volumes also make it easier to hide market manipulation?

Possibly. But there are no sure answers yet. Stock exchange sources confirm that FIIs have indeed been extremely active in the specific time intervals when the market has violently gyrated. What remains unclear is whether these FIIs represent genuine foreign institutional investment or are fronts for Indian money.

ALSO unclear is whether dozens of FIIs, or at least their sub-accounts, could be acting in concert to induce volatility and create short-term profit opportunities for themselves. In India, market kingpins over the past few decades have been known to operate through dozens of brokerage firms across four or five bourses. Is it then inconceivable that the trading of a score or more sub-accounts are controlled by a single group?

Only the regulator or the stock exchanges are in a position to find out. But even if their analysis does detect suspicious trading patterns, it will still be a difficult task to track beneficial ownership or prove that the manipulators were acting in concert.

What can the regulator do in these circumstances to maintain investor confidence? It can put more information out in the public domain; for instance the trading operations of insurance companies and Unit Trust of India. It can also hasten FII registration and hope that fresh portfolio investment will make manipulation more difficult. Thirdly, it can ignore criticism of vested interests and remain vigilant about the quality of FII money.

-- Sucheta Dalal