The budget, the bull and the BSE: Asiamoney cover story, June 2001

Asiamoney cover story, June 2001 (with Saibal Dasgupta)

 India’s groundbreaking, reformist budget has been followed not by momentum and acclaim, but by a stock market collapse, several conspicuous arrests and the banning of brokerages including CSFB. Helped by access to confidential government documents, Chris Wright with Saibal Dasgupta examine whether the country is caught in a permanent pattern of scandal and upheaval, or instead making brave but painful progress towards market reform.

 On February 28, Indian finance minister Yashwant Sinha faced the Lok Sabha (House of the People), the lower house of India’s parliament, and presented a budget that many observers would later call the best for a decade. It was greeted with delight by astonished analysts across the international banking community, who swiftly put out buy recommendations in notes with names like “sunshine on the horizon”. When Asiamoney asked Goldman Sachs strategist Anand Aithal for his suggestions for the Asian finance minister of the year shortly afterwards, he echoed the sentiments of many when he said of Sinha: “If 30% of what he says in this budget is implemented, he will run away with next year’s award.”

But the euphoria lasted less than 48 hours. Within that time the market had unaccountably crashed, and less than three months later India’s markets are back in a familiar mess. The intervening period has seen a sorry procession of scandal and collapse: the stock markets have dropped by a quarter; the president of the Bombay Stock Exchange (BSE) has resigned and had his brokerages banned from trading; his replacement at the BSE has also been removed along with all other broker directors; several brokerages (including Credit Suisse First Boston (CSFB)) have been banned; and the country’s most celebrated investor, Ketan Parekh, has been arrested and incarcerated for allegedly defrauding a bank.

The phrase ‘three steps forward, two steps back’ turns up with monotonous regularity in interviews about India, especially among foreign investors. There are moments of great optimism, when the country’s vast potential seems likely to be realized; then there are crushing collapses that suggest just how much work needs to be done. So what happened this time? And where does it leave India’s markets now?

 The budget

“Sir,” said Sinha on February 28, addressing GMC Balayoyi, the speaker of the Lok Sabha. “I rise to present the budget for the year 2001-2002. I do so in all humility. The challenges we face this year are awesome, made more so by the tragedy and devastation caused by the Gujarat earthquake. I hope I shall get the understanding and support of the whole House in my endeavour to meet those challenges.”

The humility ended there. What followed was revolutionary. Sinha’s budget proposed the liberalization of foreign exchange rules, allowing Indian companies to invest and raise capital abroad; announced bold and wide-ranging tax reforms in support of IT, corporates and the development of the capital markets; raised limits for foreign institutional investors; and, vitally, suggested labour law reforms, expanding companies’ abilities to cut jobs and employ contract labour. His plans to downsize six government ministries started with almost 3,000 job cuts in his own department. A new target of Rs120 billion (US$2.5 billion) was set for the flagging privatization programme, involving the sale of 27 state enterprises over the coming year. It projected GDP growth to rise from 6% to 7% this year with an eventual target of 10%. That figure, the government says, would eliminate poverty in a decade.

“It was a very good budget, I think the best in the last 10 years,” said DSP Merrill Lynch chairman Hemendra Kothari. “It is a bold step towards further liberalization of the economy.” The market echoed his sentiments. The Sensex – the Bombay Stock Exchange’s benchmark index – immediately rose 4.4%. Sinha, a gifted orator and debater, a driven reformer, and even something of a heart-throb (who was once an impressive athelete), must have gone home happy.

 Crash

But if he did, his excitement didn’t last. On Friday March 2, contrary to expectations, the market dropped 4%, by 176 points, mostly within a half-hour period. Sinha was livid to see such a dramatic drop in the index so soon after his budget and, suspecting malpractice, he demanded action.

The appropriate agency to bring it about was the Securities & Exchange Board of India (Sebi), and with a speed in sharp contrast to its sluggish reputation, it launched an investigation almost immediately, scouring the books of brokers who had been active around the time of the crash. On the first trading day after the fall – Monday, March 5 – it introduced a number of measures to contain volatility. Thresholds on volatility limits were changed and, two days later, short selling was effectively banned. It didn’t help: the market continued to fall (see chart), dropping below the 4,000 mark by the end of the week.

By then, there was plenty else to worry about. On March 8, an article appeared in a local newspaper saying that a tape existed of a telephone conversation between BSE president Anand Rathi and his surveillance department on the day of the crash and alleging that Rathi had pressed for, and got, market sensitive information in that phone call. This was particularly significant because Rathi, like several other directors of the notoriously club-like BSE, also owns a number of brokerages. The suggestion was that he had used information from the call for profit. Rathi resigned the same day, protesting his innocence. (See The Accused overleaf.)

And things were to get worse for Rathi. Just four days later, at 10.30pm on March 12, Sebi delivered an order to his house restraining him as director of the exchange and banning his broking businesses – Anand Rathi Securities, Navratan Capital and Securities, Rathi Global Finance and Rathi Capital and Securities – from undertaking fresh business. The order alleged much the same as the newspaper had: that he had obtained information from the surveillance department, in breach of a Sebi circular.