Even assuming the regulator has the jurisdiction to give such directions to FIIs, even if we are to ignore the moral argument against the regulator playing with market levels, even assuming the efficacy of banning pessimism from the markets, accepting the reduced efficiency of the markets, I think the worst thing about the ban is that it will reduce the cushion of short covering as every short must result in a subsequent purchase. Thus beyond a few days, the investors will face even more downward pressure assuming all other things being equal.
Even after the announcement of the ban (rather the reversal of offshore short positions), the markets fell, thus giving the announcement a miss (the screen oracle has spoken). This is probably because at Rs. 1000 crores (Rs. 100 billion) of short positions (which is only a small fraction of the market turnover -even of a single day), the short covering will get overwhelmed by plain and simple sell orders - (Wednesday alone saw an FII sale of Indian securities in that region) and short positions in the Futures and Options markets - making the markets less efficient, more likely to fall even more steeply and FIIs more suspicious of further ad hoc actions by the regulator making them flee even faster from our market.
Update: Those who came in late - the word 'apparently' in the first line needs to be underlined, SEBI 'sources' apparently deny the offshore short winding up directive. Will the real SEBI stand up?
Update: I have written a short piece in today's Times of India explaining in plain terms why any restriction on short selling is not a good idea.
My favourite quote of the day is: "How can you ban something which is not allowed". This is true of course, except for the small sliver of off shore securities shorted which are now sought to be banned/reversed.
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