The minister and the market

If Dalal Street had ears, it would have heard the collective sigh of relief from Disinvestment Minister Arun Shourie, capital market watchdog Securities and Exchange Board of India (Sebi) Chairman G N Bajpai, and a battery of investment bankers when the IBP issue closed to healthy oversubscription.

IBP is one of the six public sector undertakings (PSUs) in which the government is divesting its stake. In three weeks "" between February 20 and March 13 "" the government plans to raise Rs 14,500 crore from the market. This is certainly the most ambitious divestment programme ever.

In fiscal year 1994-95, the most successful year for primary market issues in the history of the Indian stockmarkets, the total mop-up was Rs 8,946 crore.

The government is in a tearing hurry to raise the money before the fiscal year ends so that the resources raised can be used to reduce the fiscal deficit. Unfortunately, the market doesn't care much about the government's compulsions; it has its own games to play.

Traditionally, the stock price in the secondary market is hammered down whenever there is a fresh equity offering by the same stock. The objective is simple: to get the fresh stock on offer at a cheaper rate, since the secondary market price is a benchmark for the primary market price.

This also happens whenever, say, a State Bank of India, an ICICI Bank or any other corporate entity floats an overseas issue. The foreign institutional investors (FIIs) sell their holdings in the domestic market to pick up chunks overseas at a cheaper price.

A private corporate entity can merely watch this trend. Not so the government, which has an urgent agenda. So Shourie had to act. He raised the bogey of a bear cartel and vowed to take to task those who were responsible for pulling PSU prices down.

He met the prime minister and deputy prime minister and discussed the development. He also met Intelligence Bureau Chief K P Singh. He even proposed setting up an economic intelligence unit (EIU) under the cabinet committee on security (CCS) to gather sensitive data.

At the same time Sebi also got into the act and diligently announced that it was on high alert and sought data on the trading pattern in stocks like IBP and IPCL to check if their prices were being hammered.

All these moves had their effect: stock prices went up immediately and a vastly relieved government saw subscription levels to the stocks on offer swell.

Was there anything unusual about Shourie's role? Can it not be argued that if the Reserve Bank of India (RBI) can talk the rupee up, the government can do the same for stocks? After all, in the currency market, the RBI wears two hats "" it's the regulator and the player.

But last week, Shourie wore three hats: that of the issuer (being the disinvestment minister he assumed the role of the CEO of the six companies being divested), the government, and even the regulator. And the manner in which he went about exercising those powers is open to question.

The government intervention to protect the equity market is a global trend. Over the past five years, this has happened in South Korea, Hong Kong, Malaysia, Taiwan and Japan.

But in all these cases, the governments did not threaten the short-sellers. Instead, they pumped in money directly even if the action evoked extreme reactions from the FIIs "" for instance, in Hong Kong.

In August 1998, in the aftermath of the south-east Asian crisis, the Hong Kong government pumped $15 billion into the local stock and futures markets to counter the speculative "double market play" (both equity and currency), which threatened financial stability.

Once the crisis was over, the government established the Exchange Fund Investment Limited (EFIL) in October 1998 to ensure that this portfolio was disposed of in an orderly manner.

Subsequently, an exchange-traded fund, the Tracker Fund of Hong Kong (TraHK), was launched in November 1999 as the first step of the government's disposal programme.

With an issue size of HK$ 33.3 billion (approximately $4.3 billion), TraHK's initial public offering (IPO) was the largest-ever in Asia (excluding Japan) at the time.

Around the same time, Taiwan also set up a stock market stabilisation fund and the government took direct steps to protect the market.

For instance, it allowed companies in financial difficulties and whose stock prices were regularly hitting the seven per cent down-limit to suspend trading for two months. It also threatened to adopt unspecified measures to prevent panic selling and investigate the source of rumours that would trigger a slide.

In late 2000, the Korean government raised over 1.5 trillion won ($ 1.33 billion) from the domestic pension industry to set up a stock market stabilisation fund. The move was to attract long-term investors to the country's languid stock market.

There are other recent instances, too. Malaysia's state-run Employees Provident Fund bought a $ 71 million-company controlled by Renong Bhd, which was facing severe undersubscription. This was done in the face of stiff resistance from the labour unions.

The government-run pension funds are actively supporting the stock market. What's more, they have committed an additional $ 2.28 billion to prop up the market.

Similarly, as part of a larger strategy, Japan's coalition government announced plans for a fund to buy $ 88 billion worth of shares held by banks to avert a banking crisis.

It is understood that the new fund will buy banks' shares over a three-year period before packaging them as mutual funds or other investment vehicles and reselling them to institutional or retail investors.

Clearly, there is nothing wrong in the government's intervention in the market. But the government might have been better off emulating its south-east Asian neighbours. History has shown that it has chosen other, less transparent ways to do so.

For example, in the 1990s, the Unit Trust of India (UTI) played the proxy government in the market to counter-balance the operators and FIIs whenever stocks were pulled down.

The UTI's new avatar cannot play that role any longer, which has left the government with two state-run insurance players "" Life Insurance Corporation (LIC) and General Insurance Corporation (GIC) "" to play the market on its behalf.

However, since the two insurance companies do not have enough muscle to counter the powerful FIIs and others, Shourie thought fit to use governmental machinery and psychological tactics.

A more direct way could have been the setting up of a market stabilisation fund to stave off the short sellers.

Some time ago, Sebi had discussed the possibility of a contrarian fund to arrest excessive volatility. This could have been a better way of "managing" the market.

Perhaps the most significant point to note is that Hong Kong and others have set up these funds to stave off far bigger market crises, not a few hundred points' fall in the Bombay Stock Exchange (BSE) Sensex, which triggered Shourie's outburst last week.

There is also the question of whether it is wise to use taxpayers' money to protect the interests of a minuscule number of Indian stock market investors.

BSE's market capitalisation (Rs 12 trillion) is not even half of our GDP, while most of the other markets "" where the government has stepped in "" have a market cap higher than their respective GDPs.

Finally, there is no guarantee that even such a fund will work. It may just end up providing speculators a cushion. Japan's currency market is a case in point. Whatever Shourie does, he must respect the market.