These are turbulent times, which demand extraordinary steps to arrest the fall in stock prices and minimise the damage to the economy.
Sustained fall of stock prices from January 10, 2008 to October 24, 2008 when the Sensex crashed by 59 per cent from the peak of 21,206.77 to 8,701.07 is unprecedented. In fact, several scrips in BSE 100 Index have fallen by over 60 per cent. Market capitalisation of the country has shrunk by 52 per cent from Rs 73 lakh crore at the end of December 2007 to Rs 28 lakh crore.
Previous crashes
The present crash has surpassed the worst of crashes in the past such as in 1947 following Liyakat Ali Khan’s Budget presented on February 28, 1947, when Tata Steel Deferred fell by 32 per cent to Rs 1,765 on May 27, 1947 and the Dividend Restriction Ordinance of Indira Gandhi on July 6, 1974 when Century Mills declined overnight by 29.3 per cent to Rs 424.
This certainly is not a time when just ensuring the safety of operations alone, vital as it is, is not enough. These are unusual times demanding unusual actions. What is needed is a host of measures, both short-term and medium-term (there is nothing like long-term in the stock market) to arrest the fall in stock prices and minimise the damage to the economy.
Modify risk management system
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Risk management of stock exchanges needs to be modified immediately. Exposure margins on the short side should be raised so as to act as a deterrent against speculative sales and lowered on the long side, while being adequate to cover the risk of a further fall in prices, to encourage purchases. In the like, in a sharply rising market, exposure margins should be higher on the long side to deter speculative purchases and lower on the short side to encourage sales. Similar measures taken by the stock exchange authorities in the 1991–92 crisis, when the Sensex rose by 234 per cent from June 21, 1991 to April 22, 1992 and then declined by 43 per cent to 2,529.59 on August 6, 1992, not only ensured the safety and integrity of the market, but also moderated the movement of prices. Speculative open positions need also to be regulated immediately.
Speculative short open positions above a specified level should be directed to be reduced by say five percentage points every day. In a period of sharp rise in prices, speculative long positions should in the like manner be directed to be reduced.
Outflow by FIIs
The present crisis is mainly due to the large–scale outflow of funds by the Foreign Institutional Investors (FIIs) whose mercenary approach has no concern for the host market. From the beginning of the current year till October 10, 2008, the net outflow of capital by FIIs was over Rs. 43,000 crore from about Rs. 2.95 lakh crore. In other words, the net withdrawal of FIIs during this period was about 15 percent of their holdings.
Holdings of FIIs, who are fair weather friends in Indian companies, need to be calibrated. At any rate, their net investments at any point of time should at best not be allowed to exceed at 49 percent of the issued capital of a company.
As a counter-poise to the growing impact of the FIIs on the Indian stock market, we should increase the share holding of the Indian public, particularly of Retail Individual investors (RIIs) in listed companies. As on June 30, 2007, in 1,143 scrips listed on the National Stock Exchange, while FIIs accounted for 10.53 per cent of the shares, Indian public held 13.35 per cent, out of which the share of RIIs was 7 to 8 per cent.
It is high time the proposal made by the Ministry of Finance to raise the share of Indian public to at least 25 per cent of the issued capital of a listed company, both initial and continuous, should be implemented forthwith. Companies may be given a period of not more than one year to comply with this requirement.
Action by RBI
Reduction in the cash reserve ratio (CRR) by 2.5 percentage points releasing about Rs 100,000 crore into the fund – starved banking system and other measures like reduction in repo rates by one percentage point, although welcome have come quite late in the day.
It is worth recalling that when Dow Jones index dived by 507 points (22.6 per cent) wiping out about $500 billion on October 19, 1987 (Black Monday) in a matter of hours. US Fed Chairman, Alan Greenspan, not only announced before the markets opened the next day that the Fed would provide adequate liquidity to the ailing stock markets, but also ensured that the stock markets were flooded with liquidity. There was a miracle, as markets recovered instantly.
Recently, the British Chancellor, Alistair Darling, chalked out a whopping 500 billion pounds economic reserve package for banks in the early hours of October 8, 2008, woke up the Prime Minister, George Gordan, soon thereafter to get the deal approved, and announced the package before the markets opened the next day.
In markets where minutes count, time is of essence for any rescue operation.
Market Stabilisation Fund
It is time we reconsider the proposal mooted in 2004 in the wake of Black Monday Crash on May 17, 2004 when the Sensex crashed by 842 points, to have a Market Stabilisation Fund.
There is already a Market Stabilisation Scheme launched in 2004, currently capped at Rs 2,50,000 crore kept in an escrow account, to moderate the impact of inflows or outlaws of dollars into the country- “which way the cat will jump”,- as the Finance Minister says.
Provident & pension funds
Stock market needs to be broadened. A decision on the long pending issue of permitting 5 to 10 per cent of incremental flows into Provident Funds and Pension Funds as also Funds of Public Trusts to invest in equities needs to be taken. Experience of several advanced markets in this behalf has indicated that all these Funds have benefited over years.
Time to buy
It is also time to buy stocks by all the domestic investors, including RIIs, as valuations of the stocks are quite attractive. Nifty’s current PE of about 14 times (trailing earnings) is just half of 28 PE peaked in January 2008. CNX Midcap index is cheaper still with a current PE of 8.5 as against 23 in January 2008. Doomsday Cassandra like Marc Faber should just be ignored.
Economy & banks: In good shape
Let us not forget that Indian economy is fundamentally strong, as repeatedly observed by the Finance Minister and the RBI Governor, with the growth rate in GDP of at least 7.5 per cent during the current year, inflation being tamed, foreign exchange reserves of over $ 280 billion covering merchandise import requirements of about 15 months, declining fiscal deficit with rising tax collections, etc, the Indian economy is in fine fettle.
Our banking system is safe and sound virtually untouched by the sub–prime lending crisis of Western countries. With the capital to risk–weighted asset ratio of commercial banks progressively rising to over 10 per cent as on March 31, 2008, migrating to Basel II norms not later than March 31, 2009, gross and net non-performing assets declining to 2.4 per cent at 1.1 per cent respectively as on March 31, 2008, etc, the banking system has nothing whatever to worry about.
If Dr Bimal Jalan, the then Governor of RBI, ensured that the foreign exchange crisis dogging the South-East Asian countries in 1997-98 left India untouched, Finance Minister, P Chidambaram, RBI governor, D Subbarao, and C B Bhave, chairman, SEBI, can very well ward off the dark gathering clouds of crisis from the Indian skies.
The author is former Executive Director, Bombay Stock Exchange