The introduction of dematerialization of shares would change the character of the Indian market forever, and for the better, much in the way electronic trading had. It would give another leg-up to the Indian market in its quest to rub shoulders with its global counterparts, eliminate frauds by companies and brokers, improve the efficiency of stock exchange clearing houses, reduce brokerage rates and attract more FIIs.
Many FIIs were reluctant to invest in India because of the problem of fake shares. Companies were as guilty of forging share certificates as the brokers and other market
players. Physical share certificates had distinctive numbers. Companies would pledge one set of shares with lenders, borrowing money against them. They would then print another bunch of certificates with the same distinctive numbers, and introduce them in the market through a friendly broker or through one of their own privately owned companies. They could do so, safe in the knowledge that the original set of shares would be in the custody of the lenders so long as there was no default on the interest payments to the lender.
Much to the dismay of those who played the market with forged shares, dematerialized shares were fungible; they did not have any distinctive numbers or specific identification. In fact, it was during the process of dematerialization of shares that many instances of fake shares came to light, which otherwise would have gone unnoticed for a very long time. Many companies had more shares in circulation than were legitimately issued by them.
Dematerialization immensely helped reduce the settlement risk and shortened settlement cycles, both of which were critical for upgrading the clearing and settlement system.
Another major market reform undertaken by SEBI in 1996 was getting stock exchanges to set up clearing corporations and trade guarantee funds. With this, investors no longer had to worry about counterparty risk. The clearing corporation would ensure pay-out even when a party to a deal defaulted on an obligation, and would later recover the dues from the
defaulter.
Trading volumes continued to soar because of the ease with which shares could now be bought and sold. On the flip side, retail investors increasingly started speculating instead of buying and holding shares for the long term as they used to earlier. They would buy and sell within the weekly settlement, happy to make a small profit. Of course, they would lose money as well. Speculation was addictive, and even though most retail investors rarely made consistent profits, the memory of their winning trades would raise hopes of bigger gains and keep them going.
As a result, the percentage of shares that resulted in delivery or actually changed hands fell steeply. To deter overtrading, SEBI introduced daily margins and fixed intra-day trading limits for brokers. There were limits to the positions brokers could take in individual stocks. This was done to make it difficult for any one broker to manipulate an illiquid stock.
authorities rarely enforced this rule. Brokers knew that if they insisted on margins their clients would shift business to rivals willing to overlook margin requirements. Many brokers had suffered huge losses in 1992 because of client defaults. Yet, the fear of losing clients would see brokers repeating the mistake and suffering the consequences when the market crashed in 2001, and later, in 2008.
With computerization, it became easier for stock exchanges to monitor brokers’ positions and pull up members who were stepping out of line. The broking community chafed at some of these restrictions, but there was little they could do. The Indian market had no choice but to adopt global best practices if it wanted to be counted among the best international markets. And the government steadily empowered SEBI to ensure safety and integrity in the
marketplace, increasing India’s appeal to global investors.
SEBI tightened the rules for the primary market too, alarmed at the ease with which
dubious companies raised money and then duped investors. This led to a fall in the amount of money raised by companies from the primary market.
On the whole, 1996 was a tough year for making money. In addition to a slowing economy, the political uncertainty following the general elections in April-May further dampened the mood. The Congress party lost the elections, winning only 140 seats – its lowest tally ever. The BJP emerged the single largest party, with 161 seats, and was sworn into office. Within thirteen days, the Atal Bihari Vajpayee-led government quit as it failed to muster a simple majority to win the vote of confidence.
I had a fair idea of what FIIs were doing, thanks to data supplied by Mouse. But that was not of much help, as prices often moved counter to my calculations. On a couple of
occasions, I made good money but promptly lost much more the following week.
‘It is time you both started building long-term portfolios for yourselves,’ GB told me and Dilip one afternoon after we were done for the day. ‘Speculation is a good way to build your initial capital, but you cannot make your retirement money through trading alone.’
‘Investment too is speculation after all, isn’t it? Only that your time frame is longer,’ I said. GB grinned. ‘You are right, Lala. But the odds of making money are higher; you won’t be under pressure to cut your positions just because the price has moved against you by a few rupees. More often than not, long-term investments work out well,’ he said.
‘But this is turning out to be a terrible market, and it looks like things will only get worse. Does it make sense to buy now? Why not wait for some more time?’ Dilip asked.
‘Some rules in the market never change. And one of them is that nobody can ever catch the top or bottom. Besides, to make a good profit, you need to buy cheap. And when can you do that? Only when there is despair all around. Is this the best time to buy stocks for the long term? I really don’t know. Maybe the market could fall some more. But what is the
probability of making a good profit by buying at these prices? I would say, quite high,’ GB replied.
I found merit in GB’s argument. But I was not good at understanding business models or reading balance sheets. Frankly speaking, I don’t think anybody could claim to be an expert in identifying potential winners. People took calculated bets and some of them paid off. I took GB’s advice on the stocks to buy for the long term. He too was no expert and had no pretensions of being one. But from doing trades for the big boys, he had a reasonable understanding of companies.
Once in a while, he would try to pass off some theory of theirs as his own. He would not say that it was his original thought, but he would not attribute it to anybody either. And I would try to needle him while keeping a straight face.
‘Does Nemishbhai think it can happen?’ I asked at the end of one such spiel. ‘Who said Nemishbhai said that?’ GB snapped.
‘Don’t always assume things . . . I have some ideas of my own too,’ he said, somewhat testily.
The year 1997 began on a promising note.
The market steadily rose in the run-up to the Budget.
Finance Minister Palaniappan Chidambaram’s first full-year Budget surpassed market expectations. Peak personal income tax and corporate tax for domestic companies were slashed. In a major boost for the IT sector, export profits were exempt from Minimum Alternate Tax. The FII investment limit in listed companies was raised, and dividends were made tax-free for the shareholder. The Budget also laid the foundation for the first round of disinvestment in PSUs, and announced in-principle approval of buyback of shares, subject to certain conditions. The peak customs duty rate was lowered, and so were duty rates on a wide range of imports. The media, industry and stock market were simply bowled over by what was dubbed as a ‘Dream Budget’.
But the celebrations were premature. On 30 March, a Sunday, the Congress party, without any warning, pulled the rug from under the United Front (UF) government. Tension between the Congress and the UF had been building for a while, but nobody saw matters reaching a flashpoint so very soon.
The phone lines of the kerb dealers – those who dealt in the illegal market – were ringing off the hook in Mumbai and Kolkata as panicky traders rushed to offload their outstanding buy positions. You could negotiate deals with them after market hours and then legitimize that trade by feeding the details into the stock exchange terminal the following morning. Most operators had been bullish on the market following the upbeat Budget and had huge buy positions. As for me, this was the second time within a month that I was caught on the wrong side.
The bears were plain lucky, though just for a day. The Sensex crashed nearly 300 points when markets opened for trading on Monday, but bounced back over the next couple of weeks as the Congress offered to support the UF government with the soft-spoken Inder Kumar Gujral as prime minister.
The index may have recovered quickly, but traders who lost money in that crazy session on Monday had to wait much longer to make up their losses.