Three party poopers

SMARTSHARE

Dalal Street was back to its bullish ways on Thursday and beaming with confidence after that 300-odd point rally, its tenth largest in history. The bearish sentiment that prevailed early in the week was almost forgotten. Marketmen were clearly looking beyond the February derivative expiry and had their eyes riveted on the Budget. You didn't have to ask: where's the party tonight?

But lurking in the background are three ghosts that could come to haunt the market.

Forget the Fed, BOJ is the boss

The first to appear on the scene may be made in Japan. Bank of Japan meets on February 20 and 21. Following a stronger than expected December Industrial Production growth of 0.9 per cent that came in early this week, the expectations of a rate hike have increased.

And after the healthy GDP growth of 4.8 per cent registered for the December quarter, the odds of a hike have brightened to 54 per cent from the earlier 40 per cent. Chinks appeared in the solidarity of the nine-member committee, when three broke rank and voted for a hike.

Now even if one more member crosses over, the chairman may have to cast his deciding vote. A 0.25 per cent hike by the bank would put the rates at a decade-high and the flourishing carry trade may come to a grinding halt. Possibilities of this carry trade coming to an end are not as high as the hike itself, but sentiment would definitely get dampened, casting its long shadow on the commodities and emerging markets.

Participatory Notes: bomb in our attic

PNs are derivative instruments issued by foreign security houses to entities and individuals who want to take exposure to Indian stocks. The Indian regulators do not come to know the identity of these investors.

The Tarapore Committee had recommended last year that the issue of PNs be stopped and the government had nonchalantly swept it under the carpet. But with the issue of terror money quite current, the government may have to move on this. Any move that stops or seriously curtails the use of PNs could have widespread repercussions.

If you prohibit PNs, you are effectively curbing FII inflows.

Consider this. The RBI tells us every year that out of the total FII investments, since inception, PNs account for an "X" percentage. For instance, it told last year that out of the total FII investments of Rs 1,93,918 crore that have come till April 30, 2006, 50 per cent are from the PNs. What it does not tell you is how much came last year.

But a simple back-of-the-cover calculation would tell you how much money came through this route. (Hold your breath before reading the table.)
 

Yearly Figures for PNs        (Inferred; Rs crore)
Period	Total FII Inv	Through PNs	Pns %
May 2003- April 2004	47167	23430	50
May 2004- April 2005	35829	21186	59
May 2005- April 2006	49976	44420	89

If 89 per cent of the FII investments between May 2005-April 2006 came through the PN route, what FII investments are we talking about?

If PNs are so rampant, any provision in the Finance Bill that curbs their use is likely to have serious repercussions for the markets.

Capital Gain Exemption: market catalyst

The third ghost is the possibility of ending the regime of exempting the long-term capital gains from tax. The exemption, introduced by Major Jaswant Singh in February 2003 was initially applicable to stocks in the BSE 500 list but was later on extended to all listed stocks by Mr Chidambaram.

This exemption enjoyed by investors has been the cornerstone of this rally that we have witnessed since April 2003. Any measure that rolls up this benefit has the potential to deal a severe blow to the markets. You touch it and the markets will wilt.

I am not against banning the PNs or asking the marketmen to play a little tax on the capital gains on their income. What I am saying is that if we do it, the markets are likely to take a sharp knock and investors should psychologically prepare themselves for such a move.

Join the market revelry and party well into the night. But do it with a foot in the door. Keep a watch on the clock and leave the disc before your carriage turns into a pumpkin!