Ravi Narain, deputy managing director of the National Stock Exchange (NSE), finds himself in the hot seat _ like all stock exchange administrators across the world _ as acute volatility continues to haunt bourses. Narain, who has been associated with the markets since the time he was part of the group which had gone into the setting up of the Securities and Exchange Board of India (Sebi), spoke to Vivek on the causes for the acute volatility and outlined methods which can be adopted to reduce it.
The finance minister has just made a passionate speech on how distraught he is about the volatility in the markets owing to rumour-mongering. What ails the Indian markets?
It is a fact that the investment horizon for investors has shortened dramatically. If investors earlier took an investment decision over a one year horizon, today it is barely a week. The trouble is that this has spread across to mutual funds as well, for their retail investors judge their performance on a weekly basis in terms of returns on investment. This puts pressure on them too, to take shorter horizons. And mind you, this is not something specific to the Indian markets but is true of all markets. At a recent global stock exchange summit, experts such as Mark Mobius said that they were being benchmarked by investors on a short-term horizon.
We have to get one thing very straight: volatility cannot be wished away. We have to learn to live with it. We have to learn to manage it more effectively.
What in your opinion has led to the shortening of the investment horizon and the accompanying volatility?
Two things really, in addition to the fear and greed syndrome which has, of course, always been there since markets came up.
First, we have been talking of infotech companies and now dotcoms, the fact remains that a lot of people have not got a proper perception of these companies. Markets are led by a perception of the value of a company. When there is a mismatch between this perception of a company's value and the actual value that it commands, it leads to volatility.
The greater the mismatch, the greater the volatility. Investors are currently confused about the valuations of these companies and this is fuelling high volatility.
Second, increasingly investors are not taking into account the fact that while they go ahead in search for higher returns, they must also remember that this would bring with it a higher risk as well.
While they quantify the returns on a short-term horizon, they do not quantify the risk which comes along with this high short-term return. This is why they act in a herd like manner and panic on rumours for they think that they would cover their risk by being the first to exit.
Are Indian markets being affected more by rumours than developed markets or is it the same all over?
Rumours are impacting Indian markets more as other markets are far more institutionalised. The herd mentality is greater here owing to the large retail market that we have. Institutions are more judgmental and have the capability to take different views in account and hence not get too affected by rumours.
Rumours themselves have to be divided into two kinds.
One, the company-specific rumours on which considerable progress has been made by stock exchanges, as we can immediately seek from a company, confirmation of any rumour or report. Lot of companies are now approaching us to know more about disclosures and we expect a new culture of disclosure developing among corporate India.
The second type is more general in nature and these are hard to confirm or deny. These are complicated to handle and hence are taken advantage of by some manipulators.
The ability of a market to absorb a rumour depends on its ability to segregate facts from fiction and this capability again is dependant on the level to which a market has been institutionalised.
So what needs to be done to manage volatility more effectively?
Three things. One is to introduce index-based futures immediately. This will reduce volatility as we would be able to clearly segregate our cash and futures markets. Currently, they are all rolled into one.
Secondly, we must introduce rolling settlements as these would be linked to the success of a derivatives market as we would be able to develop a sound cash and futures market.
The third thing that should be done is to keep encouraging institutionalisation of the Indian markets.
The policy makers have taken several steps in the past few years to encourage investors to go to mutual funds and these steps now need to be enhanced.
But how do you handle the issue of manipulation? Is not manipulation rampant or else how do you see such wild swings on absurd rumours?
We are not disputing that there is no manipulation. The fact that such rumours are having such huge impact and that too so suddenly, it shows that markets are certainly getting manipulated by vested interests.
This will call for a lot of off-site investigations and as stock exchanges are limited in probing only upto the broker level, they would have to work closely with the securities regulator to catch the manipulators.
Lot of progress has been made on this front but a lot still needs to be done. We have to remain on guards against it as this is not something which can be done overnight but as the entire market evolves these issues will be addressed.
