I have a piece in today's ET on the idea that capital markets need to be shut down - this was derived from a twitter thread that I ran on the same topic. I argue why market should neither be shut nor tampered with. Please find below the whole piece:
The market is a mirror. Hiding it will not make us more beautiful. Hiding half of it, (short selling restrictions) will scare people, who know they cannot rely on it to fully reflect themselves. Similarly, distorting the markets will not only not make the markets more beautiful, but will provide false comfort that we are now prepared for what will happen next. A distorting mirror is used for carnivals and circuses. A marketplace is one which has buyers and sellers. Just like a clapping sound requires two hands. Restricting one hand doesn't mean that we get half the sound. We get nothing.
Many have argued against opening markets because the exchanges too have employees and their commute will jeopardise their lives. Exchanges aren't really Vespas and they can run from remote locations. They are designed like that. This human cost can be further reduced. The more serious question is the lives of the entire ecosystem including brokers, custodians etc. And that is a fair criticism. The government must support the ecosystem - reports of employees of brokers being stopped from work exist. If the ecosystem is essential, it must be supported.
On Friday, SEBI came out with a circular restricting short positions. Though its impact was rather peripheral in terms of restrictions, foreign investors perhaps saw it as a willingness to interfere with the markets. The result was an unprecedented fall in the markets while most of the world did not see such a steep fall.
If we change the rules of the game while the game is on, investors, particularly foreign ones will sell more quickly. Try to restrict derivative shorts, read as temporary exit, and foreign investors will sell in the cash markets and permanently exit. You may ask, why cater to the damn foreign investors, after all we don't owe them anything? But almost all the selling is being done by foreign investors. So spooking them seems a really bad idea.
So will shutting the markets till say 31st March help bring order back from chaos? We don't need to go too far back to see what happened in Philippines. Last week they shut the markets for 2 days and it opened 24% down. We should learn from their mistake.
Markets are more interconnected than ever before. Cross border connections are self-fulfilling and connected to the forex markets. If foreign investors get spooked, they think there will be an outflow, an outflow gets the rupee depreciated, increasing tomorrow’s losses. So why not sell today instead. Changes in rules of the game mid-way also means that we get downgraded in the MSCI and other international indices. Thus, causing further sale pressure by passive international funds which have no choice but to follow the indices.
Second and third order problems within India are also huge. Our equity markets are connected to the debt markets, to the money markets, the banking system, NBFCs (think LAS), mutual funds and ETFs and corporate India in ways too numerous to detail here. Suffice it to say, domestic institutional players will have two major problems, exit and valuation. Since all other markets are perfunctorily functional - they will face liquidity and valuation complications, when the equity market catches a seizure. For mayhem to occur, we need a small minority of determined sellers. Nassim Taleb articulated this brilliantly in his book, Skin in the Game, showing how markets react in a way that is disproportionate to the impetus. A single order of only 50 billion dollars was able to destabilise a 30 trillion dollar world market in the Société General rouge trader case. The market Taleb says, is like a large movie theatre with a small door. Today, someone has already shouted fire – let’s not increase the panic.
Financial markets deal with mis-priced illiquid assets routinely. And it is not a happy situation. They need to estimate illiquid corporate debt by extrapolation, estimates and other rough means. When markets are closed, people must do this with equity shares. People will assume the worst and provide for worst case scenarios. An NBFC lending against shares will discount the market price by (say) a 24% fall in price (using estimates from Philippines) when markets are shut. Margin calls will be made to top up for this estimated loss. This will be even more catastrophic for promoters than what they are facing today.
People assume that capital markets are just places of punting for remorseless finance types. That statement is true - but it's only 1% of the truth. Capital markets are working even in these impossible times. Yes Bank and many others continue to raise capital bringing capital relief. ESOPs continue to be valued and exercised, exits continue to be provided in trades, risk allocation continues shifting risk and capital in tens of millions of trades, values continue to be assigned.
Are people happy or satisfied with the current situation - of course not. People have lost their entire life's savings if they were to liquidate today. Are there any easy solutions? Probably not. But closing the markets is surely not one of them. At best it will postpone the inevitable, at worst, it will accelerate systemic problems and create trust issues in the markets.
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