India's crash: Blame it on global
integration By Paranjoy Guha
Thakurta
NEW DELHI - On an unprecedented
roll for two years, India's stock markets
nosedived this past fortnight, with investors
nervous after losing more than US$100 billion in
wealth refusing to heed Finance Minister
Palaniappan Chidambaram's advice to "stay
invested".
On Monday, celebrations for the
second anniversary of the formation of the
center-left United Progressive Alliance (UPA)
government in New Delhi were dampened by news that
the sensitive index of the stock exchange at
Mumbai, India's commercial capital, had crashed by
a record 10.2%, necessitating a one-hour
suspension of trading.
That was the
steepest-ever fall in the 250-year-old history of
the
Bombay (as Mumbai was called)
Stock Exchange (BSE), Asia's second-largest stock
exchange after Tokyo. Though the markets
recovered, headlines on financial newspapers
screamed: "Manic Monday" and "Market Mayhem". One
paper renamed Dalal (broker) Street - the lane in
downtown Mumbai on which the imposing skyscraper
housing the BSE headquarters is situated - Halal
(butcher) Street .
On May 18, stock
indices had tanked, making many observers wonder
if what was happening was not merely a "technical
correction" in an overheated market.
"I
really don't know where the markets will go from
here, whether a bear phase has begun or not, but
what I am reasonably sure about is that this is
the end of the bull run for now," Dhirendra Kumar,
head of Value Research, an independent New
Delhi-based firm engaged in research on mutual
funds, told Inter Press Service (IPS).
"Small investors have been shaken up and
many of them won't return to the markets in a
hurry," he added.
Over the past two weeks,
the sensitive index of the BSE has come down by
roughly one-fifth from peak levels touched on May
10. "What has happened is a certain amount of
nervousness in the market. My advice to retail
investors is to stay invested," Chidambaram said
on the afternoon of May 22 outside parliament,
where opposition legislators had called for his
resignation because of the "failure" of the
government to check price volatility.
Two
years ago, on May 17, 2004, the stock markets
collapsed when it became known that the UPA
government would have to depend on the outside
support of 61 members of parliament belonging to
communist parties, opposed to rapid
liberalization, for its survival in power.
This time around, the trigger for the
market meltdown appeared to have its origin in
events that had taken place far away, and
communist leaders said they felt vindicated by
their stand that closer integration with global
markets would make the Indian markets more
vulnerable to global trends.
The decision
of the US Federal Reserve Bank to increase
interest rates on May 16, the sudden fall in the
prices of steel, copper, zinc and other metals at
the London Metal Exchange a day later and the fact
that international prices of crude oil have
continued to remain rather high, have all had an
impact on India's stock markets in an increasingly
integrated and globalized economic environment.
Markets in India are not the only ones to
have crashed over the past fortnight. The emerging
markets of Russia, China, Brazil and Indonesia had
also declined, Chidambaram pointed out.
In
recent years, share values in India have been
influenced to a considerable extent by
international brokerages. Currently, over 700
foreign institutional investors (FIIs) have been
registered with the country's regulatory
authority, the Securities and Exchange Board of
India (SEBI). These FIIs operate roughly 2,000
sub-accounts in India's stock exchanges.
An FII is an institution established or
incorporated outside India that invests in
securities in the country. A sub-account could
include foreign corporate entities, institutions,
individuals, funds or portfolios established
outside the country (whether incorporated or not)
on whose behalf investments are made by an FII.
While FIIs have been allowed to invest in
Indian securities from September 1992 onwards - as
the country began opening up an economy closed for
decades - the regulations governing the activities
of FIIs were notified by the SEBI more than three
years later, that is, in November 1995.
Many FIIs operate out of Mauritius, the
small island state in the Indian Ocean, with which
India has a double-taxation avoidance agreement.
The reason why FIIs prefer to be based in
Mauritius is that they can avoid paying taxes on
short-term capital gains.
After Thursday's
crash, Communist Party of India-Marxist (CPI-M)
member of parliament Sitaram Yechuri urged
Chidambaram to review the agreement with Mauritius
but was told there was no scope for "unilaterally"
reviewing a treaty involving two sovereign
nation-states.
Market analysts believe
that because Mauritius is a tax haven for FIIs
operating in India, the provisions of the
India-Mauritius tax treaty have been misused by
unscrupulous operators to launder illegal funds
and channel these into stock markets. SEBI's
regulations allow FIIs to operate on behalf of
clients on the basis of "participatory notes" that
often do not reveal the original source of the
funds.
India's central bank and top
monetary authority, the Reserve Bank of India
(RBI), recently submitted a note of dissent on the
disclosure of sources of funds invested by FIIs to
a report prepared by an official committee headed
by Ashok Lahiri, chief economic adviser to the
government of India in the Finance Ministry. Many
analysts are wary of speculative flows of "hot
money" from "hedge funds" moving in and out of the
country.
"Once you open your market to
foreign players, you have no choice but to accept
a situation where there could be considerable
volatility," Professor D N Rao, of the Jawaharlal
Nehru University, told IPS.
Despite the
sudden collapse in share values, not everybody is
pessimistic. India remains a growth story, they
say, because its economy is growing every year by
7-8%, inflation is under control at 3-4%, foreign
currency reserves are buoyant at over US$160
billion and certain sectors - such as information
technology, automobiles and pharmaceuticals - are
booming like never before.
"Only those
investors who had parked their funds in the stock
markets over the last year in the hope of reaping
windfall short-term gains are today deeply
disappointed, not long-term investors," said Ashok
Kumar Bhattacharya, managing editor, Business
Standard, a leading multi-edition financial daily,
in an IPS interview.
SEBI chairman M
Damodaran has stated that unlike in the past, the
recent volatility in the country's stock exchanges
had not been accompanied by any financial
scandals. During 1992 and 2001, India's share
markets crashed in the wake of government
authorities unearthing major irregularities in
securities transactions.
Even today, most
small and middle-class investors in the country
are apprehensive of investing hard-earned savings
in equity shares or even mutual funds, preferring
instead bank deposits that are considered "safer",
even if returns are lower. According to the RBI,
nearly 40% of the country's total household
savings are kept in banks, against less than 2% in
stocks and shares.
