Sucheta Dalal :The Sensex is already showing signs of vertigo
Sucheta Dalal

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The Sensex is already showing signs of vertigo  

Apr 3, 2006

On August 20 last year, Madhukar, then a whole-time member of the Securities and Exchange Board of India (Sebi), startled the financial community by predicting that the Sensex would cross 16,000 during the current financial year.


In the past few days, the galloping Sensex seemed determined to fulfill Madhukar’s prophecy before the financial year ended. The Sensex at 11,300 is a long way from 16,000, but don’t forget that in August 2005 it was hovering at just 7,800. At 11,300, the Sensex is already showing signs of vertigo. After the scorching but volatile rise of 100 points a day, Friday’s flattish market was enough to trigger an involved debate, desperate crystal-gazing and a deep analysis of derivatives’ trading positions to check for dark clouds on the sunny market horizon. Clearly, investors are euphoric but nervous. And even the experts are unwilling to bet on which way the Sensex will move in the short term.


However, our regulators seem extraordinarily complacent, apparently be-cause the gush of foreign money queuing to enter India comprises a wide spectrum of countries that had never considered us an investment destination. That is probably why the Securities and Exchange Board of India (Sebi) has made no attempt to administer even a temporary coolant in the form of higher margins that would force a controlled unwinding of some leveraged trading positions. The biggest worry today is the lack of information on investors, the quality of their money or their trading horizons and motivations. This was a problem even during the Harshad Mehta and Ketan Parekh scams. Although the leading players were openly identified, their source of funds was always a mystery. Even at that time, it was only after the collapse (caused mainly due to hugely leveraged positions) and the subsequent investigation that regulators discovered how Mehta and Parekh were colluding with some bankers to dip into their vast pool of bank funds.


Quality of information is an even bigger worry this time. The success of our automated trading systems and the ability of Indian stock exchanges to ride out the May 17, 2004 disaster (Manic Monday) has been an occasion for well-deserved self-congratulation. But the real test will be the ability of stock exchanges to handle a significant correction in this bull market, where trading volumes are now touching an incredible Rs 65,000 crore.


• Our regulators are not trying even a temporary cooling of the frenzy

• The test will be the ability of exchanges to handle significant correction

• The niggling worry is the FII mix of sound and volatile money


We also have new evidence that automated systems create audit trails only if these are properly configured to capture and detect irregular trades and manipulation. While the government would like to dismiss what is called the demat scam as an isolated case of collusion and fraud by a group of people, it has fortuitously exposed a dangerous systemic deficiency before this could erupt into an even bigger scandal. Despite automated processes, the depository system allowed imperfect data capture, permitting multiple accounts and failing to detect large pre-listing trades, as well as the demat and re-materialisation of the capital of small companies several times over.


Can we dare to assume that the secondary market systems will not throw up such surprises? Over the years, bourses have never been able to track a single case of price ramping, although the turnover charts always show a clear correlation between the ramping up of any given stock (including low volume, low liquidity scrips) and a massive jump in its trading volumes. This time, the regulators have to deal with two new elements — large derivatives’ volumes and significant faceless foreign investment. Although there is no evidence of sustained ramping of prices, market insiders openly track the significant market operations and rapid acquisitions of a high-profile industrialist and a bull operator who has joined hands with him. Market insiders even mention the specific foreign institutional investors (FIIs) whose operations are apparently controlled by this duo and their managers.


But the regulator is in no position to ask tough questions merely on the basis of suspicion. Foreign institutional investment is one mass that includes good quality money from pension funds and large mutual funds, as well as laundered Indian money and volatile hedge fund money coming in through Participatory Notes. And that remains a niggling source of worry.


-- Sucheta Dalal