Sucheta Dalal :Reality check: Markets in for turbulent times
Sucheta Dalal

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Reality check: Markets in for turbulent times  

Jul 10, 2006

The Indian capital market seems set for some turbulent times. Every time the Bull run shows signs of a revival, there is negative news that causes prices to dive again; clearly even the expectation that good corporate results for the recent quarter will lift indices will be tempered by recent political developments.


On Friday, rumours about the Prime Minister’s resignation sent prices tumbling. Although the Congress Party issued quick denials, there seems to have been some fire beneath that smoke. The party leadership will do well not to push the mild-mannered Prime Minister too far; a person who is scrupulously honest has little incentive to hang on to a chair when political expediency dictates decisions and he takes all the blame.


If foreign investors and portfolio funds have learnt to show enormous patience in dealing with the slow pace of India’s economic reforms, marked by frequent rollback of key decisions, it owes a lot to the faith they have in the leadership of an economist and a reformer. The world recognises that it is difficult to push reforms with a coalition government in a democratic nation with an obdurate bureaucracy (ask Jim Rogers) and a high level of corruption.


The hypocrisy of political posturing and manoeuvring is also evident to the public. From Left Party leaders who object to foreign investment but holiday in Tuscany or a doctor-Minister who thinks nothing of humiliating an eminent cardiac surgeon and destroying the morale and autonomy of one of India’s best-run institutions or even the machinations of another ally, which goes back on its commitment to minor disinvestment plans after emerging victorious in Tamil Nadu—the media reports it all.


Similarly, it is difficult to miss the fact that there is no more talk about opening up the retail sector to foreign direct investment, while Reliance Industries pushes ahead with its giant rollout plans ahead of any threat or competition from Wal-Mart. In fact, Reliance is also set to become the biggest land owner in the country, buying up tens of thousand acres of land at throwaway prices under a SEZ policy that has clearly gone out of control. It is almost like the power policy of the 1990s, also under a Congress government, which ended in an incredible mess that has escalated power shortages and crippled infrastructure development.


The SEZ (Special Economic Zones) policy, which provides little clarity on the impact of generous tax holidays and myriad concessions on the economy, may also come to a grinding halt, but nobody is complaining because every corporate group is rushing off to grab chunks of valuable real estate to set up SEZs, exactly like they chased power projects in the past.


Astonishingly, there are plenty of large investors who believe that India will muddle through this mess and juggle all the contradictions to keep pushing the reform process.


However, the speed with which the disinvestment decision in Nalco and Neyveli Lignite was rolled back is a cause for concern. As far as capital markets are concerned, they have to balance the impact of this roll-back with the expectation of another round of spectacular corporate results for the recent quarter.


If this suggests a season of volatile market fluctuations, then the situation is unlikely to be helped by the Securities and Exchange Board of India’s (Sebi) decision to permit short-selling by institutional investors, including Foreign investors (FIIs). Sebi’s secondary market advisory committee has apparently recommended that institutions be allowed to short-sell with the caveat that a proper lending and borrowing mechanism should be put in place.


This recommendation was probably made in the midst of the monster Bull run that took the benchmark Sensex soaring past 12,000. At that time, room for a contrary view may have cooled the fervour and reduced the savageness of the subsequent correction that chopped a couple of thousand points from the Sensex. Is it still a good idea when the market is volatile and prices continue to drift downwards?


The Reserve Bank of India (RBI) has long expressed concern over short-selling on the grounds that application of Know Your Customer (KYC) norms is difficult in connection with FIIs. This is a fact. Large chunks of FII investment is really Indian money stashed abroad coming back through hedge funds. Many of these hedge funds are managed from Singapore and London by discredited stock brokers and fund managers.


Although Sebi rules demand disclosure of beneficial ownership by FIIs, anecdotal reports suggest that the regulator has no clue about the billions of dollars of tax-evaded Indian money that is invested in the Indian market as tax-free FII investment. Many of these investors are interested in maximising profits and it remains to be seen if they will exploit the short-selling rules to manipulate markets.


Also, the role of hedge funds is a worry around the world. Charlie Munger, partner of the legendary Warren Buffet is another critic of hedge fund managers. Last week, he called hedge funds a ‘‘ghastly culture’’, accused hedge fund managers ‘‘of doing anything and everything to keep fees high and profits flowing’’ and warned that ‘‘there will be a terrible scandal in due course’’.


Do we want to give them more freedom to speculate in the Indian market? It is also pertinent to note that US Supreme Court last week shot down an attempt by the Securities Exchange Commission to regulate hedge funds. This makes a mockery of Sebi’s rule that FII sub-accounts must be entities that are regulated in their home jurisdiction.


Having obtained board clearance to allow short-selling by institutions, Sebi will do well not to hurry up with its implementation when the market is so turbulent. What was necessary and would have worked well in the roaring Bull phase may prove to be an embarrassment in a volatile market, especially since Sebi has still to get a handle on beneficial ownership of a big chunk of market participants.



-- Sucheta Dalal