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Date: Mon, 16 Nov 1998 23:06:00
Subject: "Black Monday",REDACTION
Organization: Public Interest Research Group, N.Delhi
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October 5, 1998: "Black Monday" in Indian Financial Markets
By Kavaljit Singh
October 5, 1998 will be remembered as "Black Monday" in the history
of Indian financial markets, particularly in the context of post-
globalisation phase. On this day, the Bombay Stock Exchange
Sensitivity Index (Sensex) recorded a sizeable fall of about 224
points (nearly 7.20 per cent). This fall was second only to the crash
of 570 points on April 28, 1992 and the biggest in a single day in
1998. The steep fall on October 5, 1998 has caused ripples in the
subdued Indian financial markets.1
In the history of global financial markets, the October 19, 1987 is
popularly known as "Black Monday" because on this day the financial
markets of U.S., Europe and Asia witnessed biggest one-day drop since
the days of Great Depression of the 1930s. Since, at that time, the
Indian financial markets were not globally integrated, the global
fall had no impact at all. However, the fall of October 1998 reveals
the inherent dangers of unbridled globalisation of financial markets
in India. It also reveals the nefarious role of foreign institutional
investors (FIIs)- who are also known as international fund managers -
in creating an artificial crisis in the financial markets.
Reasons of Collapse: Economic Fundamentals or FII-led "Bear Cartel"?
What were the reasons behind this fall? Did the economic fundamentals
changed drastically overnight to warrant such a fall? Or some
powerful lobbies in the form of "bear cartel" were at work?
On a prima facie basis, it appears that efforts were made by a
powerful FII-led "bear cartel" to create panic in the markets and
thereby benefit from its collapse. It also appears that after
suffering heavy losses in the Hong Kong during the months of August-
September 1998 when the Hong Kong Monetary Authorities (HKMA)
intervened heavily in the markets, the "bear cartel" has shifted its
activities to Indian markets. The fact that FII-led "bear cartel" was
responsible for this steep fall is well documented in a note
submitted by a financial institution to the Indian government.2
The Modus Operandi
To understand the real causes of steep fall in the Indian financial
markets, it is important to know how the "bear cartel" operates. The
"bear cartel" consists of fewer players (as compared to bull which
are usually very large in numbers) and therefore, they can better act
in tandem. The "bear cartel" operates on short selling (in simple
terms, short selling means selling the stocks even without owning
them). In order to make profit, the cartel is dependent on a fall in
the market so that they can buy their positions at lower prices.
Therefore, their profits are dependent on fall in the markets and
erosion of share values. To achieve the fall in the markets, a number
of strategies are used. For instance, rumours are spread to create
panic and simultaneously short selling is introduced to create an
impression that rumours are correct. As financial markets are more
prone to "herd behaviour" and panic can spread out quickly, a crisis-
like situation is artificially created by a handful of unscrupulous
manipulators.
The Events
In the first week of October, the attack was launched by FII-led
"bear cartel" on India's domestic financial institutions,
particularly the government-owned Unit Trust of India (UTI). The UTI
is the India's first and largest mutual fund, with assets worth more
than Indian Rupees (Rs.) 600 billion (approx. US $14 billion) and
investors base of 25 million. It is the biggest player in the Indian
financial markets. The UTI's popular scheme, US-64, alone has a
corpus of Rs. 220 billion ( $5 billion).3
On Tuesday, September 29, 1998, reports appeared in the media that
the reserves of US-64 had turned negative because it had a very low
net-asset value (NAV).4 There is no doubt that UTI has been operating
without much transparency, public scrutiny and accountability. Quite
often, the political masters have misused UTI to prop up the markets
to depict a rosy picture of Indian economy. Its over exposure to
equity in a falling market has brought US-64 to a bad state. Besides,
lobbying and pressure by business groups, bureaucrats and political
masters have also forced UTI to acquire low-performing equities over
the years. As a cumulative impact of these developments, the
proportion of equity vis-a-vis debt and other assets of US-64 had
changed from 28:72 in 1991-92 to 64:36 in 1997-98.
On October 2, 1998, the UTI's chairman, P.S. Subramanyam announced
that it would reduce the proportion of equity in the next few years,
to overcome the problem. Since the markets were closed till Monday,
the statement by chairman had no impact but it prompted the FII-led
"bear cartel" to start short selling. On Monday, October 5, 1998,
when the markets opened, Morgan Stanley, the largest FIIs in India
with a large exposure in the Indian markets and second only to UTI,
resorted to large scale selling of stocks. On this day, FIIs were net
sellers of stocks worth Rs.1360 million ($32 million) while Morgan
Stanley alone sold stocks Rs.940 million ($22 million) during October
5-8, 1998.5 The purchase by Morgan Stanley during this period
amounted to just Rs.36.9 million ($0.8 million) while the sale
amounted to Rs.971 million ($23 million).
Further, the data shows that Morgan Stanley was the largest net
seller among the FIIs - the next in line were Pictet & CIE and
Fleming. (see Table 1). Surprisingly, Morgan Stanley, just a week
ago, had bought stocks worth Rs.2000 million ($47.6 million) in
response to upgrading of India in their index.
The attack on US-64 was launched at two levels. On one level, an
impression was created through spreading rumours and planting stories
in the media that investments in UTI's US-64 scheme are risky because
reserves have turned negative. This prompted ordinary investors' to
redeem their units. In the first four days (October 5-8, 1998), over
Rs. 5500 million ($131 million) worth of units were redeemed. On the
other level, the stocks in which US-64 had investments were
selectively hammered down. With the help of a sophisticated tool
called programme trading6 (which is banned in several countries), the
FII-led "bear cartel" succeeded in creating disproportionate fall in
the stock prices as well as in the Sensex.
In this fiasco, the role of the media, particularly the business
media, has been very negative. Certain newspapers were used by the
"bear cartel" to spread rumours while others remained silent on the
role of FII-led "bear cartel". In fact, one business daily, The Hindu
BusinessLine in its editorial titled, "Don't see demons" justified
the selling decision of Morgan Stanley and criticised the government
for summoning it for an explanation.7
The Response of Indian Authorities
Perhaps for the first time ever since the process of global
integration of Indian financial markets was initiated in mid-1990s,
the Indian authorities are facing a situation under which not only
its financial markets but also its own financial institutions are
under attack. Anticipating that any action against the "bear cartel"
will send a negative signal to FIIs who may further desert the panic-
ridden markets, the Indian authorities have failed to impose strict
penalties on them. This failure is seen as a major victory by "bear
cartel" while the ordinary investor is helplessly witnessing a
complete meltdown of his wealth by a handful of unscrupulous
operators.
On the receipt of note from a financial institution, the Securities
and Exchange Board of India (SEBI) has launched investigations to
look into the role of FII-led "bear cartel".8 In this regard, the
chief of Morgan Stanley in India, Vikram Gandhi, was summoned by SEBI
and finance ministry to explain the rationale behind the sale.
However, Vikram Gandhi denied any role in working in collusion with a
"bear cartel" and linked the large sales to "certain redemption" in
Thailand.9 The investigations by SEBI are going on and much awaited
in the market circles.
Lessons to be Learnt
The Indian authorities can learn two important lessons from this
fiasco. Firstly, the functioning of UTI need to be improved. The
management of UTI should be given complete autonomy in decision-
making process and no bureaucratic and political pressures should be
allowed. Like any other mutual fund, the UTI should also be brought
under the same regulatory scrutiny. For instance, the UTI should
regularly disclose its NAV of various unit schemes. The standards
related to disclosures, transparency and accountability should also
be applied to it.
Secondly, the regulatory authorities will have to devise new
mechanisms to control the activities of "bear cartel". There is a
growing feeling among many market analysts that the system works in
favour of the bears.10 They argue that stock exchange authorities
impose margins and other penalties when the market goes up while no
margins are imposed when the markets crash. It is very rare that
margins are imposed on short sellers who deliberately manipulate the
prices down. The authorities will have to take notice of "bear
cartel". Illegal practices such as short selling should be
immediately banned on the down tick as in the case of mature markets
of US and Hong Kong.
If situation arises, the Indian authorities should not abdicate its
responsibility of intervening in the markets. Not long ago, even the
laissez-faire Hong Kong authorities intervened to protect its markets
from the "bear cartel". Recently, the US authorities also intervened
in bailing out the hedge fund, Long-Term Capital Management (LTCM).
In the long run, the Indian authorities will have to remove loopholes
from its financial system and strictly enforce regulations consisting
of better disclosure standards, stiff penalties for violators and
measures to curb programmed trading, insider trading and other
illegal practices.
It is high time that the Indian authorities realise the importance
and relevance of strict regulations and controls, especially in the
context of financial deregulation and globalisation. Otherwise, the
nefarious activities of "bear cartel" and others may cause an
irreparable damage to Indian financial system. A serious rethinking
on the so-called benefits of opening up the domestic financial
markets to global finance capital is needed.
Table 1: Top 10 FII Sellers
(From October 5-7, 1998) (in Rs. million)
-----------------------------------------------
FIIs Sales Purchases
-----------------------------------------------
Morgan Stanley 971.8 36.9
Emerging Markets 413.5 229.6
PICTET & CIE 281.7 0
ACM 26.4 58.3
Fleming 246.4 17.3
Schroders 23.1 75.8
GMO Trust 197.7 0
General Electric 100.8 0
Capital 100.9 179.9
Pioneering 99.6 0
------------------------------------------------
Source: Investor's Guide, The Economic Times, October 19-25, 1998.
Notes and References:
1. Unlike the financial markets of the U.S., Japan, and Hong Kong,
the Indian markets are well known for prolonged bear phases and
short-lived bull phases. Even the biggest booms in the Indian
markets (e.g. in 1992 and 1994) were short-lived whereas the
downtrend, which followed, lasted for many years.
2. This note purported to be submitted by a financial institution
(name not disclosed) was published in The Economic Times, October
19- 25, 1998.
3. R. Padmanabhan and V. Sridhar, "Coping with the markets,"
Frontline, November 6, 1998.
4. Net assets is the sum total of the market value of all
investments plus accured income minus the liabilities and
expenses. Net asset value represents the net assets on a per unit
basis. It is equal to the net assets divided by the number of
outstanding units.
5. "Morgan sparked the Monday tumble," The Economic Times, October
9, 1998.
6. The program trading is a sophisticated tool in which a computer
floppy is used to give simultaneous instructions for selling a
chosen set of stocks. The instructions are so given that in a
span of 1 minute these chosen stocks drop sharply together as if
some new development has occurred in the market. A series of
unverifiable rumours are immediately circulated in the market
giving the justification of the fall. The stop-loss limits
existing in the computers get activated which further lengthen
the fall. In effect through a program trading prices are hammered
down without reason and they do not bounce back because the
market is dazed by the gravity of the fall and rumours cannot be
verified.
7. "Don't see demons," editorial in The Hindu Business Line, October
21, 1998.
8. "Sebi to probe role of bear cartel," The Financial Express,
October 8, 1998.
9. "Morgan Stanley's Gandhi clears air on Black Monday," The
Economic Times, October 17, 1998; and "Morgan Stanley links
offloading to redemption pressure in Thailand," The Financial
Express, October 16, 1998.
10. Puneet Jain,"Dancing with the bear," Investor's Guide, The
Economic Times, October 19-25, 1998.
Kavaljit Singh is the coordinator of Public Interest Research Group.
He is author of A Citizen's Guide to the Globalization of Finance
(Madhyam Books, Delhi and Zed Books, London, 1998). His forthcoming
publications include Regulating Global Capital Flows: Policy
Challenges and Alternatives.
The author can be contacted at the following address:
Public Interest Research Group
142, Maitri Apartments
Plot # 28, Patparganj
Delhi- 1100 92
Ph: 2221081, 2432054
Fax: 2224233
E-mail: •••@••.•••
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KAVALJIT SINGH
PUBLIC INTEREST RESEARCH GROUP/MADHYAM BOOKS
142,MAITRI APARTMENTS,
PLOT#28, PATPARGANJ,
DELHI-110092
PHONE:91-11-2432054,2221081
FAX:91-11-2224233
EMAIL:•••@••.•••
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