Panic at the Bombay Stock Exchange

January 28, 2008

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THE bull-run on the Bombay Stock Exchange (BSE) was brought to an abrupt halt last week, as thousands of panicky investors — both retail and institutional — dumped shares in a desperate bid to exit the markets.

The Sensex, the benchmark index on the BSE, which had gained nearly 50 per cent in 2007, lost an astounding 13 per cent on Monday and Tuesday, before recovering a little on Wednesday.

The turmoil in the Indian stock markets was caused primarily by the hurricane that was ripping through the American economy; and when the ‘Wall Street whiplash’ occurred – following a record-breaking 75 basis points cut in interest rates by the US Federal Reserve, resulting in a surge in American stock prices – it had the desired results in India’s financial and commercial capital, with stocks regaining part of the loss.

But the yo-yoing stock indices last week reflected the nervousness of millions of investors, most of who had made a neat pile over the past few months in the stock markets. The trigger for the bloodbath on Dalal Street – Mumbai’s Wall Street – was the ongoing crisis in the US economy caused by the subprime mortgage crisis and the billions of dollars that leading investment banks have had to write-off over the past few weeks.

With fears of a full-blown recession in the US in this election year, investors here worried that foreign institutional investors (FIIs) – who have been pouring billions of dollars into the Indian capital markets – would pull out funds in 2008. Other Asian and European stock markets were also snared on fears of an American recession, resulting in a cataclysmic fall in global share prices.

Indian stock market indices have been on a decline for the past fortnight, but last week saw one of the bloodiest episodes in its history. On Monday, the markets crashed by a whopping seven per cent, taking cue from the global markets. FIIs were booking profits and pulling out funds, leading to rumours that many were trying to make up for the losses suffered by their principals in the US in the subprime mortgage crisis.

On Tuesday, all hell broke loose at the opening session and the stock exchange authorities had to shut down trading for an hour after a precipitous 2,300-point fall in the first 10 minutes of the session. The Sensex plunged to a low of 15,300 – it had peaked at 21,206 on January 10 – and investor wealth declined by a massive Rs18 trillion (almost $470 billion). Following last week’s meltdown, India’s market capitalisation is down to a little over $1.5 trillion.

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DESPITE all the talk about the equity cult having gained deep roots in India, there are a little under six million retail investors who play the markets on a regular basis. But the proliferation of round-the-clock television news and business channels and the blazing headlines in the pink pages of economic and business dailies has given the stock markets a larger-than-life profile in India.

Last week, electronic and print media journalists were busy interviewing investors who claimed to have lost millions of rupees overnight, blaming the government, the prime minister, the finance minister, stock market and banking regulators, foreign investors, Indian institutional investors – in fact all and sundry – for their woes. Some brokers at the BSE went to ridiculous levels, blasting the authorities for installing a bronze sculpture of a charging bull at the entrance to the exchange, and attributing the fall in the markets to its presence. The bull had been installed just a few days earlier.

Many naïve investors expect stock markets to give them astounding returns year after year, and are reluctant to accept the fact that there’s a downside risk to investing in the capital markets. And there are equally gullible commentators – both in the media and in politics – who are willing to shed tears for the losses suffered by these babes in the woods.

BJP leader and former finance minister Yashwant Sinha (who should be knowing better, since he was a senior government leader) and Communist Party of India (CPI) leaders A.B. Bardhan and Gurudas Dasgupta were among those who smelt a rat; they called for a high-level probe into the ‘manipulations’ and demanded that the government ensure ‘orderly functioning’ of the markets. Apparently, decades of dirigisme and indoctrination in a romantic Nehruvian socialist ideology still hobble the thinking of several Indian politicians in the 21st century.

Finance Minister P. Chidambaram, however, drew a clear distinction between the “robust, real economy of India,” and the “financial economy,” which was being swayed by the upheavals in the US. The real economy in India was in good shape, driven by its own robust investment and consumption. He also clarified that the huge losses sustained by American investment banks in the US, following the subprime crisis, would not have much of an impact on the Indian capital markets, as these banks did not have significant exposure here.

Chidambaram is confident the Indian economy will continue to grow at nine per cent this year as well; both corporate profits and income-tax collections are at all-time highs. The Reserve Bank of India (RBI), the country’s central bank, had assured the government that brokers and market players would not be deprived of liquidity at this stage, he asserted.

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THE RBI is likely to follow the US Federal Reserve and announce a rate cut in its monetary policy review later this month. Worried about inflationary pressures, the central bank had been raising interest rates last year, a move that had been criticised by many industry bodies. The United Progressive Alliance (UPA) government was also toying with the idea of mid-term polls last year, in the wake of its failure to get the Indo-US nuclear treaty on board, and the central bank was under pressure to curb interest rates.

But this has had a disastrous impact on Indian exports, as the rupee emerged significantly stronger against the US dollar and other currencies. If the RBI maintains the current interest rates, India will continue attracting billions of dollars from international investors out to earn a quick buck, which could strengthen the rupee even further, but hurting exports.

Interest rates in India are way above those in the developed world: the repo rate (the rate at which the central bank lends short-term money to banks) is 7.75 per cent and the reverse repo rate (the return banks earn on excess funds parked with the RBI) is six per cent, as against a LIBOR (London Inter Bank Offer Rate) of 3.68 per cent.

Analysts expect the RBI to cut the repo rate by 25 basis points, and also a reduction in the cash reserve ratio (CRR). “With inflation under control and hovering around three per cent, it is the right time for the RBI to cut repo and reverse repo rates to cover the relative competitive disadvantage India is currently in on macro economic fundamentals,” says Sunil Bharti, president, Confederation of Indian Industry (CII), and chairman of the Bharti group. “Easing of interest rates would strengthen the economic fundamentals and also boost investors' confidence.”

The Federation of Indian Chambers of Commerce and Industry (FICCI) has also suggested an immediate 25 basis points cut in repo rate, to be followed by a similar cut two months later. While inflation was within tolerable limits, the RBI has to revise interest rates to tackle industrial slowdown, says the chamber.

With the stock markets having taken a massive beating last week, domestic financial institutions — including state-owned Life Insurance Corporation of India — have been busy buying up billions of rupees worth of stocks. Even private life insurers were acquiring large chunks of shares, grabbing the opportunity to build up their long-term portfolios.