STOCK MARKET IN TURMOIL – LESSONS FOR INVESTORS

By Prof. S. L. N. SIMHA, J. MULRAJ, Dr. AJAY SHAH

Summary

Stock Market in Turmoil – Lessons for Investors is a 2001 Forum of Free Enterprise pamphlet collecting three contributions on the Indian stock market crisis that followed the collapse of the early-nineties bull run and the IT-stock hype. Prof. S. L. N. Simha, a former Principal Adviser of the Reserve Bank of India, opens with a forensic essay on “The Stock Market Debacle” originally carried by Southern Economist, blaming the Government, the RBI and SEBI more than speculators for permitting bank credit, badla carry-overs, mutual-fund share lending and weak regulatory independence to inflate the bubble. J. Mulraj, a financial analyst and Times of India columnist, follows with “Some Rules for Investors,” a talk delivered at a Forum of Free Enterprise meeting in Mumbai on 18 April 2001, tracing the structural shift from open-outcry to screen-based trading, the rise of mutual funds and institutional ownership, and the global dotcom valuation mania. A third contribution by Dr. Ajay Shah is announced on the cover but falls outside the rendered pages.

Essays

The Stock Market Debacle

By Prof. S. L. N. Simha

Simha argues that the recurring Indian stock-market debacles are not primarily the fault of speculators but of regulators who, for almost two decades, treated a bullish stock market as a proxy for economic strength. He charges the Government, the Reserve Bank of India and SEBI with permitting banks and depository institutions to lend against shares, engage in badla carry-overs and loan securities to bear operators, while neglecting margin discipline and self-regulation by exchanges. Citing Keynes’s beauty-contest analogy to explain why even eminent experts cannot price equities reliably, he warns small savers off direct equity exposure and proposes a battery of reforms: a separate banking-supervision authority independent of the RBI, a SEBI restructured along the lines of the U.S. SEC with statutory independence and five-year tenures, prohibition of bank credit and share-lending for stock transactions, short rolling settlements in place of badla, mandatory bonus issues and tighter dividend conventions, dematerialisation of share transfers through banks, and a massive investor-education programme.

The essay ends on a deliberately deflationary note: undue importance has been given to share-price movements as an index of the country’s economic performance, “like the misguided importance we have given to cricket”. Simha cautions against rushing to introduce derivatives trading beyond stock-index futures, citing the near-bankruptcy of Long-Term Capital Management, and insists that scams confined to individuals will peter out but those involving banks and mutual funds threaten the capital market itself.

• Primary responsibility for the debacle lies with Government, RBI and SEBI rather than with speculators, whose job is to maximise private gain.
• Bank credit, badla carry-overs and securities lending by mutual funds and depository institutions are identified as the mechanisms by which speculation was financed.
• SEBI, modeled too weakly on the U.S. SEC, must be statutorily insulated from the Finance Ministry with five-year board tenures and emoluments comparable to RBI Governors.
• Small savers should stay out of direct equity, taking the route only through mutual funds — and only marginally, citing T. T. Krishnamachari’s logic in setting up the Unit Trust of India.
• Reforms proposed include a separate banking-supervision authority, short rolling settlements, prohibition of share-lending, mandatory bonus issues, dematerialisation, and an investor-education drive.
• Government should remain neutral in markets — neither help bulls nor bears — and avoid creating hype around equity investment as an index of national performance.

Some Rules for Investors

By J. Mulraj

Mulraj, who joined the Bombay Stock Exchange in 1985, narrates the structural transformation of Indian markets from open-outcry floor trading and jobber-mediated price quotes to screen-based trading, paperless settlement and a competitive brokerage industry following foreign entry. He argues that the transaction-cost gains have given investors “greater control over their investment destiny” — but warns that the parallel shift in ownership patterns, with mutual funds replacing individuals as the dominant holders, has introduced its own herd-driven volatility. In the rendered pages he diagnoses the 2001 turmoil as the joint product of domestic factors and a global venture-capital mania that funded dotcoms on “eyeballs rather than profits,” comparing it to a tulip mania without the deliberate fraud.

He identifies open-ended NAV-based mutual funds as a marketing rather than financial success and as a structural source of short-termism, citing Lucent Technologies’ fall after thirteen quarters of expectation-beating and the Infosys correction in India. The text breaks off mid-argument at the close of the rendered chunk; the third contribution by Dr. Ajay Shah lies past the cut.

• The transaction side of Indian markets has improved dramatically with screen-based trading, paperless settlement and foreign brokerage competition.
• Brokerages in India fell uniformly with electronic trading — unlike post-Big-Bang London, where retail customers were charged 4 per cent while institutions paid a quarter of a per cent.
• Ownership has shifted from individuals to institutions: the U.S. ratio inverted over thirty years, and India is moving the same way.
• Open-ended NAV-based mutual funds are a marketing innovation, not a financial one, and structurally encourage short-termism in corporate management.
• The dotcom mania exemplified valuation by “eyeballs rather than profits,” with disruptive technologies (Napster, p2p) compounding the difficulty of predicting business survival.

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