Indian Financial Crash, Part II

Les Schaffer schaffer at
Mon Apr 9 14:35:11 MDT 2001

[ part II from Mac Stainsby ]

Regulation: too little and too late

All the above mentioned instances of frauds and manipulations reveal
the weak regulatory and supervisory framework in India. It also points
out the lax attitude of the regulatory authorities to prevent such
frauds. The surveillance system of regulatory authorities is in such a
bad state that they had absolutely no clue while the frauds were being

Unfortunately, in most of the instances, the response of the
regulatory agencies has been reactive rather than proactive. Like
popular Indian movies, the regulatory agencies came into the picture
when the damage had already been done. This is despite the fact that
regulatory authorities have an armory of instruments at their disposal
to prevent such frauds. According to L C Gupta, former member of SEBI
Board, even when actions are taken, they are generally ad hoc in
nature. Because of these reasons, there is a growing feeling that the
regulatory authorities, particularly the SEBI, tend to protect the
interests of big players rather than small investors.

It is common knowledge that there are not only bear cartels but also
bull cartels playing their games in the Indian financial markets. Why
SEBI has not taken any action against such cartels in the past? What
about insider trading, which is so rampant in the Indian markets? What
about circular trading (a group of brokers buy and sell shares to
generate volumes in specific stocks basically to lure other investors)
so prevalent in the Indian markets? Why the proposal for uniform
settlement cycle across different exchanges has not been implemented
for the past five years? Why didn't SEBI take early action to prevent
the nexus of the brokers and directors running the stock exchanges?
Why SEBI has not taken any action regarding the Indian money routed
through the FIIs? Why the SEBI turned a blind eye to the illegal
business transactions in Calcutta Stock Exchange? These are some of
the questions SEBI has so far not answered.

These questions not only expose the incompetence of SEBI but also the
lack of political will among our policy makers. Although our policy
makers are keen to adopt the Anglo-Saxon system of running the
domestic financial sector, they have ignored the fact that such
financial frauds would have attracted tough punitive measures even in
the so-called "free market" economies such as the US and Hong Kong. In
these countries, insider trading and short selling are serious
offences. Further, there is a speedy investigation mechanism in place
and the culprits are quickly booked. Not long ago, the junk bond
trader Michael Milken spent several years in jail besides paying
nearly $1 billion in penalties. Further, he was debarred from entering
stock markets for the whole life. The notorious manipulator, Ivan
Boesky, was also jailed for his involvement in insider
trading. Likewise, two financial journalists were jailed in the US for
18 years on the charge of insider trading.

On the contrary, the situation in India is completely
different. Scamsters and fraudsters are well-respected public figures
in India, whose advice is frequently sought by financial markets and
the media. Instead of spending their lifetime in jail, scamsters lead
a lavish lifestyle and write newspaper columns. The cases against
Harshad Mehta and his associates in the securities scam of 1992 are
still pending in the court. Almost ten years have passed, still no one
has any clue when these culprits will finally be punished.

What ails Indian financial markets?

Despite the growing integration of Indian financial markets with the
global markets along with the introduction of sophisticated investment
instruments and electronic trading, the financial markets in India are
highly inefficient and are frequently manipulated by a handful of
rogue traders. A nexus consisting of big institutional
investor-businessman-banker-official-politician is powerful enough to
manipulate the financial markets to its advantage. While the small
retail investor is always a loser in market manipulations. The retail
investor only enters the financial markets when the share prices are
either at peak or the bull run is over. Before the retail investor
could understand the games played by big bulls and bears, big
operators move out and the prices collapse. Unfortunately, the small
investor ends up as the only long player in the Indian financial
markets. Various attempts by the government to encourage small
investors to return to financial markets are not going to yield
positive results until and unless the Indian authorities ensure that
savings of small investors will not be held to ransom by a handful of
unscrupulous big operators and manipulators.

Due to frequent market manipulations and frauds, the retail market has
almost been wiped out in India thereby providing more leeway to big
operators and institutional fund managers. Except a few big operators
and domestic institutional investors such as the UTI, the Indian
financial markets are dominated by the FIIs. Although there are over
500 FIIs registered in India, only top 5 FIIs contribute over 40 per
cent of the total portfolio investments. Instead of taming such
volatile and speculative investments, the successive governments in
India have been continuously relaxing controls and regulations in
order to increase their hold over the Indian markets. The latest
"dream budget" also offers several new incentives to FIIs such as cuts
in dividend tax and capital gains tax besides allowing FIIs to acquire
up to 49 per cent of equity of any Indian company. Instead of learning
lessons from the Mexican and the Southeast Asian financial crisis, and
consequently adopting policy measures to avert a similar crisis in the
country, the successive governments in India in the nineties have been
recklessly liberalizing existing regulations on such volatile private
capital flows.

In fact, over 90 per cent of total volume of trading in stock market
is accounted by hardly 50 shares in India. A year back, when the
information technology boom was in full swing, the market
capitalization of two Indian software companies, Wipro and Infosys,
was more than the entire GDP of Pakistan, estimated to be $55
billion. At that time, the total market capitalization of the BSE
alone was nearly 62 per cent of India's GDP.

Some time ago, US Federal Reserve Bank Chairman, Alan Greenspan, used
the phrase "irrational exuberance" to explain the excesses of Wall
Street. It appears that Indian financial markets may also qualify for
the same, as they have become extremely speculative, volatile and
irrational. According to calculations done by L. C. Gupta, the
speculative trading in the Indian financial markets is one of the
highest in the world. The ratio of trading volume to market
capitalization in India is about three times the ratio in the US and
UK. The irrational behavior of financial markets can be

gauged from the fact that on February 14, 2000, there were no sellers
of shares of well-known software company, Infosys, in the entire
Indian markets, while the next day, there were no buyers of it. Is
there any better term other than "schizophrenia" to explain such
irrational behavior?

These facts bring out the sordid state of affairs in the Indian
financial markets.  There is a serious crisis of confidence in the
credibility and competence of SEBI to regulate Indian markets. There
is no denying that SEBI needs to be given more powers in terms of
search, seizure and imposition of penalties to ensure that fraudsters
don 't dare to commit frauds. Several proposals to further empower
SEBI have been made in the past, but the Ministry of Finance is
sitting on these proposals. Apart from adding on to the powers of
SEBI, its staff should be entrained in special skills to ensure better
market intelligence and surveillance. This becomes much more important
in the present context when sophisticated investment tools such as
financial derivatives are being introduced in the Indian financial

Besides strengthening the stock markets, policy makers will have to
give equal attention to strengthen the banking sector. One of the main
reasons behind increased volatility in the financial markets is the
private bank lending to traders against shares. Although the public
sector banks have very little or no exposure, it is the private sector
banks such as Global Trust Bank, Standard Chartered and Citibank that
have been lending huge money to big operators in the stock markets. In
an event of massive stock crash, banks with heavy exposure in the
stock markets would also be in deep trouble. Therefore, the central
bank should further strengthen prudential norms and regulations
related to bank lending. Furthermore, with the breaking down of
traditional walls between the stock markets and the banking sector, a
collapse in stock market can have a devastating effect on the banking
sector. Therefore, there should be more coordination between the
central bank and SEBI to regularly monitor the developments in the
financial markets and banking sector.

Even the small cooperative banks must come under close scrutiny of the
regulatory authorities. By and large, the authorities have adopted a
complacent attitude that co operative banks are too small to be
regulated. The prudential norms enforced in commercial banks in the
early 1990s were implemented in cooperative banks only in
1999-2000. Cooperative banks were established in the country to serve
such poor people and small businesses whose needs were ignored by both
public sector banks and big private commercial banks. Recent
experience, however, shows that some of these banks have gone beyond
their original mandate and have diverted money to speculative
businesses including stock markets, bullion trade and money
markets. The run on the Madhavpura Mercantile Cooperative Bank,
followed up by frauds at Classic Cooperative Bank and City Union Bank,
reveal the systemic weaknesses in the entire cooperative banking
sector. With a total deposit of Rs. 15000 million, the MMCB was the
second largest cooperative bank in the state of Gujarat. By offering
higher interest rates, this bank was able to raise deposits amounting
to Rs. 5000 million from small cooperative banks in the state. In
order to prevent the spill over effect of the default on the entire
payments system, the central bank quickly took over the MMCB.  Since
the problems are more systemic, the regulation of the entire
cooperative banking sector needs to be strengthened by the central

Concluding Remarks

To conclude, the need of the hour is complete overhauling of the
entire financial system, which resembles a casino in which assets are
traded primarily for speculative profit rather than for the benefit of
the real economy. Rather than serving the interests of people at
large, the financial casino serves the interests of a handful of
speculators, financiers and manipulators. The financial casino is
worse than an ordinary casino in the sense that the players in an
ordinary casino follow certain rules. It is the financial casino that
perpetuates market crashes thereby adversely affecting millions of
ordinary investors who have put their savings and assets at its
disposal. Even those who are not part of financial casino (such as
workers, farmers and small traders) and who would not like their
savings to be put into this casino, are involuntarily being made to
play in this casino because it affects savings, investments, exchange
rates and interest rates.

Unfortunately, the successive governments in India have been promoting
the financial casino as part of financial sector reforms prescribed by
the IMF and the World Bank.  Whereas, India's financial system has
been predominantly bank-based and more suited to local conditions. The
banks have played a major role in the industrial and agricultural
development of the country. Despite the fact that the banks have been
the largest mobilizers of household savings, Indian authorities are
determined to transform the entire financial system into a financial
markets-based one. Various fiscal incentives and concessions are being
offered to savers to divert their savings away from the banks to the
financial markets. Efforts to promote financial markets at the cost of
banks would prove counterproductive to the entire financial sector as
well as the real economy.

Since the government has promised to make public the investigation
reports of SEBI and RBI on the current market meltdown, these reports
are eagerly awaited. But the moot question is: what would be the fate
of these reports? Would these reports also gather dust like the
previous reports? Would time-bound punitive actions be initiated
against greedy manipulators and rogue traders who are bent upon
destroying not only the financial markets but also the entire macro


Kavaljit Singh is the coordinator of Public Interest Research Centre,
New Delhi. His latest book is Taming Global Financial Flows (Zed
Books, London, 2000).

NOTE: Asia-Europe Dialogue Project holds the copyright of this
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contact Kavaljit Singh at <kaval at>

Macdonald Stainsby
Rad-Green List: Radical anti-capitalist environmental discussion.
Leninist-International: Building bridges in the tradition of V.I. Lenin.
In the contradiction lies the hope.
                                     --Bertholt Brecht

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