Whose Money is it anyway?

There is too much dubious money in the economy that is playing havoc with its integrity and injecting inflationary tendencies. This is real bad news for middle-class ambitions

Hardnews Bureau Delhi

As Union finance minister in 1991, Manmohan Singh never lost sleep over the gyrations of the stock market. He probably realised that the stock market impacted such an infinitesimal section of the population of the country that there was no need to get too worked up over its mercurial conduct. Indeed, if Bombay Bull Harshad Mehta made merry with the funds of nationalised banks, it could be attributed to the somnolence of the financial administrators.

Similar equanimity was in short supply when the holders of participatory notes (PN) hammered the stock market on October 17 and brought down the Mumbai Sensex (MSE) by 1,743 points. This happened when they got to know that the Security and Exchanges Board of India (SEBI) was likely to ban the PNs.

Participatory notes are financial instruments used by investors or hedge funds that are not registered with the SEBI to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. It is difficult to establish the identity of the holders of these PNs who bring in substantial amount of funds to the Indian stock market.

SEBI's move stemmed from the fear that dubious funds of uncertain origin were coming to the Indian market that could undermine the country's economic stability and lead to undesirable appreciation of the Indian currency. SEBI woke up late on this issue — PNs have been actively used since 1996. SEBI did not realise that the anonymous investors would react so aggressively to their move.

A flustered Union Finance Minister, P Chidambaram, who was in Washington, tried to assuage the feelings of investors when he tried to explain the import of SEBI's move and how it was not meant to ban the PNs in entirety. He drew a fine distinction between those that would be banned and others that would be allowed to bring in their funds. He beseeched PN-holders to register as foreign institutional investors with the SEBI.

The bloodbath at the bourses forced a shutdown of the stock market on October 17. However, after Chidambaram's quick intervention, the market climbed up by a whopping 1,400 odd points — almost making up for all the points the Sensex had lost in the morning. A large part of the recovery was fuelled by heavy purchases by domestic Indian companies, which is a euphemism for financial institutions like LIC, IDBI and government banks. Evidently, the government did not want the Sensex to go down further after attaining a high of 19,000 plus.

The finance minister's statement drew a lot of flak from the BJP which demanded a joint parliamentary committee probe on what was going on. Former BJP MP from Mumbai, Kirit Somaiya, complained to the chief vigilance commissioner, comptroller and auditor general (CAG) and the SEBI. His complaint was that the SEBI changed the memo on PNs after Chidambaram's statement and that the finance minister tried to “talk up” the revival of the Sensex. Somaiya accused Chidambaram of knowing that the FII were buying shares at a time when no trading was taking place. He wanted to know: how did the finance minister know about this?

The crash of October 17 triggered disquiet in business and government circles. Many of the issues impacting the stock market were discussed in a seminar at the Delhi-based Institute for Studies in Industrial Development (ISID) on October 23. In a lucid presentation, Professor Chalapathi Rao, an eagle-eyed market and economy-watcher, laid bare some of the facts that have become a casualty of deliberate obfuscation. Quoting extensively from joint parliamentary committee (JPC) and Reserve Bank of India (RBI) reports on earlier stock scams, Rao proved that much of the leaven witnessed in the stock market was the doing of corporate houses. He also confirmed what was earlier being feared in government circles — that the SEBI enjoys neither the autonomy nor the muscle to bring the guilty corporate houses to book.

Its ineffectiveness was highlighted by the JPC on the Ketan Parekh stock scam: “SEBI furnished four sets of interim reports inclusive of its investigation regarding scrips of certain corporate bodies… Due to non-availability of a final report from SEBI, the committee could not have the opportunity to take oral evidence of these corporate bodies.” In other words, the SEBI just did not give its final findings into the involvement of the corporate house in the scam.

A similar malaise had plagued the earlier JPC on the Harshad Mehta scam. Indeed, the investigating agencies could not explain the role of the corporate houses and the end use of the Rs 3,500 crore securities scam.

In many ways, there has been little change in the cast of the players that are rigging the market which is after all composed of only 30 shares in BSE and 50 in NIFTY — open for manipulation. The rumour in Mumbai is that one company, which wants to be the richest in the world, is pushing up the Sensex. There are other players too, who are taking the market higher by bringing their own funds or using hedge funds. Their design is to bring in their initial public offering (IPO) at a time when the stock market is close to 22,000 points so that they can make a big killing in the market. By a rough estimate there is an IPO a day for almost a month.

However, the big ones include Reliance Power and MGF-Emaar. So chaotic and criminalised is the stock market that the regulators have not tried to find out how much of “round tripping” is taking place — Indian money coming back through the Mauritius route to the stock market. The regulators, the pink press and business channels are also not reading the fine print.

The booming stock market has begun to hurt many exporters due to the appreciating rupee against dollar. And that is the reason there is a sizable lobby in the government and the chambers of commerce that wants to reign in foreign investors. Intervention by the SEBI to do away with PNs in 18 months is prompted by those who have begun to bleed due to the rampaging stock market.

The modus operandi adopted by foreign institutional investors is that when they bring in billions of dollars the rupee appreciates and when they buy shares the share prices starts rising. These investors benefit doubly by using the time lag by selling artificially high priced shares and encash for dollars at the appreciated price of the rupee.

The rupee's steady appreciation has led to the loss of Rs 65,065.66 from its currency and gold revaluation account   in the year 2006-2007. This does not take into account the appreciation from Rs 43.6 to a dollar at the end of March 2007 to Rs 39.51 in the middle of October. Surely, this rise would cause    further erosion in the value of our dollar reserves.

According to a former secretary of the government of India, “The dollars that are coming could be drug money coming for laundering. There could be a lot of Indian politicians and bureaucrats who must be washing their ill-gotten wealth through PNs.” He argues that if these people pull out of the stock market then India may suffer a crisis similar to that witnessed in Thailand in 1997. “No economic purpose has been served by this enormous rise in the Sensex except to allow speculators, both Indian and foreigner, to reap huge profits,” he said.

The truth is, the government may have  begun the process of regulating capital flows in the economy, but there is too much of criminality and dubious funds in the economy that are playing havoc with its integrity and injecting inflationary tendencies.

This is real bad news for middle-class ambitions.

• The absorptive capacity of the Indian economy is doubtful and much of the capital flow is determined by high interest rate that Indian government offers.
• A large portions of the funds are coming from USA after the sub prime crisis hit American stock market.
• A large portion of the funds are being used to pick up shares of companies that have very poor fundamentals. Many of them are companies that have not shown new business activity.