Market players have been rattled from the time SEBI put out a discussion paper on Offshore Derivative Instruments (Participatory Notes or PNs). The FM attempted to calm the market stating that it was an attempt to moderate the copius flow of dollars into the country.
The Chairman of SEBI gave the impression that they wanted to restrict the use of PNs. When told that the FM wants to moderate copius flow of dollars, he was not sure whether the objective was to monitor the quality or quantity of money inflow. So he said there are multiple objectives. Not very flattering; the regulator who issued the discussion paper is not sure of the objective.
What certainly came through mid week was the regulators are not independent. They work as extension of the government. Recall how the Forward Markets Commission was asked to place curbs in January and February 2007. The government banned tur and urad futures in the last week of January 2007 expecting a price fall in these commodities.
On 28th February 2007 in addition to his prepared Budget speech, the FM announced the Government's decision to take wheat and paddy out of the futures market.
Now the attempt is to control the capital flow, price the dollar and stem the tide in the stock exchanges. The FM says he is shocked that the BSE index rose by 1000 points from 18000 to 19000 in 4 trading sessions. He possibly did not realize that the climb was barely 5.5%.
The FM came through like King Canute. He wants to control the free market and does not realize in a global economy, his powers are limited. He must realize that managing macro economic fundamentals is about planning; it is about taking control of uncertainty.
SEBI’s job is also to reduce the uncertainty of market players. Restricting trade and PNs is about forcing people to not plan for the future. Asking FIIs to unwind by October 25 or even within 18 months is curbing free trade. Fixing dollar exchange parity is not their job.
The sensible strategy is to address the genuine difficulties of market design, regulation and supervision, so that foreigners know that they are welcome as any other player. They have a role to play in a mature market economy. This requires breaking with policy decisions made in the 1950s.
Strengthening the physical market, improving flow of information, distinguishing hedging and speculative transactions, and treating hedgers and speculators differentially are some aspects that deserve attention. SEBI should also realize that there is really no difference in the color of money. Call it rupees or dollars or euro, they need respect, support and protection.
FM should realize that he needs to have his act together, if the registered FIIs bring much more dollars than what came through PNs. Is he or the Guvnor of RBI ready for that eventuality? If our economy continues to grow at 8% y-o-y and corporate performance is on improvement of average 20% y-o-y, funds will stampede into the market. Can the BSE index be controlled?
BSE index shares have an EPS of Rs.1050 considering FY09 estimates. Index of 20000 would mean PE of 19, which is not high for an economy on fast track. If funds come to the market in a hurry, we might have index of 24000 by March 2009 results. PE of 23 will get justified. How would the Guvnor price the dollar? What would the FM do with index of 24000?
Subprime mortgages have taken a toll of most financial players in US and large number of them in Europe and Japan. Central banks have pumped billions of dollars to these institutions to help manage their liquidity and create confidence in the market. These banks and mortgage companies will attempt to make up their losses by rushing into economies that look poised to grow. India would attract them. What would the Guvnor do with dollar inflow?
FM as the Chief Manager of the economy must the lead in improving the systems and processes. Multi-level answers are required. Some of them would be:
Discontinue registering FIIs in the present form. Make no distinction between various market players. Create a level playing ground.
Permit foreigners to register with banks, brokers and DPs in the same manner that domestic participants do. Have common KYC norms;
Attempt to liquidate overseas debt by using the more permanent FDI flows. That will reduce interest burden on the exchequer, and reduce the deficit;
Alternatively, get infrastructure developed using the dollar balance;
Reduce fiscal deficit and minimize the need to print monies. Curb non-plan expenditure. Get state governments to reduce their deficits; Bring inflation lower at consumer level;
Encourage Indian exporters to work for export of value added items;
Ensure the regulators such as SEBI, TRAI, RBI etc become independent and professional, and adopt best practices in their approach to market players. Regulators are not intermediaries. Their ability to provide impartial management of key areas of the economy needs to be protected.
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