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About stocks, scams and the government
Jitendra Kumar Gupta
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July 11, 2007

In February 1947, when the first finance minister Liaqat Ali Khan pulled the rug from under the business barons by raising the marginal income tax rate to 98.5 per cent, Dalal Street [Get Quote] saw its biggest ever fall. Shares of Tata Deferred (now Tata Steel [Get Quote]), tumbled close to 60 per cent and so did that of many others. Several brokers went under.

Markets can no longer go kaput these days; nor can brokers. Thanks to the sophisticated trading infrastructure and robust regulations, the market is a safer place to invest in.

While both business and markets have largely moved out of government shackles, the role of the government in the development of the stock market through setting up institutions like Unit Trust of India, National Stock Exchange and the Securities and Exchange Board of India - each of which served a useful purpose - or by bringing in more companies to the public markets, cannot be undermined.

Through the seventies, eighties and till the mid-nineties, public sector institutions like UTI, LIC [Get Quote], GIC, and public sector mutual funds ruled the market. With the entry of foreign investors, these have become marginal players.

The real boost to the stock market came after the government asked foreign companies to dilute their stake to the public in the mid-seventies.

During 1976-77, about 120 foreign companies came out with initial public offers and raised Rs 140 crore (Rs 1.4 billion), adding another 1.8 million shareholders. Some prominent companies that became public were Reckitt Benckiser, Russell Tea, Colgate, Ponds and Hindustan Lever [Get Quote].

Similarly, the real impetus to trading came after the introduction of the badla, which enabled investors to carry forward positions, rendering greater liquidity to the market. With lingering doubts about the misuse of the system, badla was banned and re-introduced several times before it was finally replaced by derivatives in 2001.

According to M R Mayya, who served as executive director of the Bombay Stock Exchange for seven years between 1987-93, the government-administered pricing for IPOs worked in favour of investors.

"Since public issue pricing was regulated by the Controller of Capital Issues, there was gross underpricing of shares during the IPO with the result that stocks would quote at multiple-times their issue price when they made the debut on the bourses," he says.

The issue price was decided based on three years' average profits and these profits were discounted at 15 per cent to determine the price-earnings ratio and the final issue price. Most issues were thus priced at a significant discount to the worth of the company. For example, Colgate came out with its issue priced at Rs 25 and was subsequently quoted at Rs 105.

Once the CCI was abolished and free pricing allowed, the primary market exploded with gross mispricing of shares and ultimately collapsed in 1993. The new issues prompted many new stock exchanges to come into effect like Jaipur, Ahmedabad, Kochi and so on. The NSE and Sebi came into being as a fall-out of the frequent scams in the capital markets.

Some concerns of the past still remain, as in the case of a roaring bull market, that merchant bankers may be pricing public issues at levels not justified by fundamentals purely because of excessive demand from foreign investors. Another concern is the grey market.

In the initial years, official trading used to happen only for a couple of hours a day (12-30 to 2.30 pm). This was followed by kerb (unofficial) trading because players liked to react to late news. But even after official trading hours were extended, kerb deals continued.

"Kerb trading used to take place notoriously on the street. I use to bring the police and drive them away," says Mayya; "there was a class of people from Rajasthan who specialised in kerb trades. They used to run the market and execute the off-market transactions."

Initially, newspapers used to publish both official as well as kerb rates because they had a bearing on the market price the next day and also threatened the integrity of the market.

Similarly, even before the introduction of derivatives, traders had access to these instruments. A veteran trader, Babu Phatak, pioneered the idea of option trading called Jota Phatak. Jota was the right to buy (call option) and Phatak was the right to see (put).

"At one level we could not stop this, and at the other level there was a feeling that it caused no harm to the overall market," Mayya remembers.

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