A job of the stock market is to engage in speculative trading, where an assessment about the future dividends of shares is translated into what one would be willing to pay for them right now. The P/E of the Nifty now stands at 17.8 and that of the Nifty Junior is at 16.8. These reflect a more sombre assessment about the prospects for India, and will (in turn) dent investment. International news has certainly played a role. All emerging markets have done badly in the last 10 days. But India has done significantly worse. A wave of bad news about how India is ruled has been streaming out, including issues of reservations, quotas, special economic zones (SEZs), abandonment of the price of Rs 60 per day for the NREG, the SEBI order on the "IPO Scam" and the Arjun Sengupta report on the unorganised sector. There is no progress on other problematic issues such as the pricing of petroleum products or the pension reforms bill. The picture we present is one of a weaker India placed in a more gloomy international setting. | |
| The partial implementation by V P Singh of the Mandal Commission report in 1990 was not unrelated to the crisis of confidence that hit the Indian economy right after that. There is an analogy between those events and the present situation. When the political class decided to fan the flames of conflict by putting quotas back on the front burner, the rational speculator took two steps back and asked how this dented the story of an India that has escaped from socialism and is headed for high growth based on rational policies. The 20% decline in the Nifty should be seen as a wake-up call for Manmohan Singh and Sonia Gandhi to think more carefully about how the country should be ruled. |
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| Stock market mechanisms, by themselves, have worked fairly well. Apart from the disruption and nervousness caused by Sebi's interim order on the "IPO Scam", the stock market has itself performed well. Monday was a particularly interesting day, where the May futures were nearing expiry, and business was shifting to the June futures. There are exaggerated fears about FIIs having "caused" this drop in prices. However, trading by FIIs is simply not big enough to shake the market, and data for recent days clearly show that FII flows are caused by Nifty returns. So far, there has been no attempt at launching a witch-hunt into the market movements, as was done in May 2004. |
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| The equity market is now the backbone of the financing of firms in India and it needs to have the highest possible liquidity and resilience to shocks. As an example, on Monday, the Nifty first dropped by 10 per cent and then recovered after a market suspension. Sebi and the ministry of finance need to reopen the policy issues on derivatives, which have stagnated for three years now. Index derivatives trading needs to take place in the Nifty Junior, alongside the Nifty, so as to reach the second tier of stocks. The system of position limits, and rules for FIIs, which were cautiously designed for the first few months of derivatives trading in India, are completely out of touch with current market conditions. The lack of direct market access has crippled arbitrage, and has thus created persistent gaps between futures prices, options prices and the underlying spot price. |
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