Foreign funds trigger meltdown, Sensex tumbles by 826 points

While most stockmarkets around the world fell, the Sensex became the worst-hit index.

MUMBAI: If you were to list the top 10 market crashes in India, Thursday's 826-point fall of the BSE Sensex wouldn't figure in it at all. That's because a fall of even this magnitude works out to only 6.76 per cent when the index is above 12,000. The crash after Harshad Mehta's excesses in 1992 still holds the title as India's worst, with the drop being 12.77 per cent then.

But with Rs2,23,000 crore of investor wealth wiped out, this surely ranks as one of the top shockers of all time, worse than the 565-point fall on Black Monday - May 17, 2004 (total fall: 11.14 per cent). On a day when all Asian stockmarkets appeared to be falling after the Dow Jones index saw its biggest drop in almost four months the previous day, the Sensex became the worst-hit index in the world.

What caused the market to tank at a time when the Indian economy is going great guns, with GDP growth crossing 8 per cent last year and 2006-07 promising another 7.5-8 per cent?

Surjit Bhalla, partner, Ox[u]s Investments, says the main culprit was Wednesday's note issued by the Central Board of Direct Taxes (CBDT) seeking opinions on whether traders should be taxed differently from investors for short-term capital gains. The markets assumed that this could impact foreign institutional investors (FIIs), who currently pay only 10 per cent on short-term capital gains. If FIIs were treated as traders, their tax liabilities would have gone up substantially — hastening their exit.

While the Indian market opened weak due to similarly weak openings in East Asia, the drop became a rout when London opened with the buzz that FIIs may be about to take a hit in India. Around 2:30pm Indian time, when falling markets forced brokers to call for higher margins from their clients, selling was accentuated as speculators hastily brought down their open positions.   

That's how the Sensex ended 826 points down rather than just 400 or 500. By the time the finance minister made his clarification on FIIs, the markets were too far gone to recover.

But the markets have had it coming for a while now, thanks largely to the steady rise in interest rates in the US, where the Federal Reserve Bank has raised rates to 5 per cent and is promising some more hikes. This has forced global fund managers to reallocate resources to the US, effectively pulling out some funds from emerging markets. In India, FIIs sold Rs865 crore worth of shares on Thursday, making May the first month in which they have pulled out funds since October 2005.

Net result: the Sensex and Nifty reported their largest ever single-day falls. While the Sensex closed at 11,391.43 points, the Nifty ended at 3,388.90 points. Some 625 BSE stocks hit the lower-circuit limits. Only 24 of the 939 stocks traded on the National Stock Exchange advanced during the day. On the BSE, this statistic stood at 263 out of 2,550.

Quite clearly, there were few buyers anywhere - except for some mutual funds. "We saw some selective buying from domestic institutions," says Sandeepa Arora, vice-president, institutional equity, at India Infoline. "Till such time as a clear direction emerges, we have told our clients to stay away from the markets," she added.

"The hardening of interest rates globally is one of the factors that saw markets across the world moving down," says Mihir Vora, senior vice-president and head of equities at ABN Amro Mutual Fund. "But the day's fall is a consequence of all markets having gone up rather sharply at the same time, and the need for a correction." While a majority of the world markets ended down, the Sensex's 6.76 per cent drop was the largest among them. Since its all-time high of 12,612 touched on May 10, 2006, the Sensex has fallen 9.68 per cent.

Among Asian markets, Indonesia (-4.19 per cent) and Pakistan (-3.65 per cent) were the other major losers in the day.

But the Sensex's fall is seen largely as much-needed correction and not a comment on the robustness of the economy. Says Shashank Bhide, chief economist, National Council of Applied Economic Research: "Interest rates were going up anyway. But what is happening in the US will have an effect and there will be pressure on interest rates here as well."

But Bhide is clear that the sky hasn't fallen. "Taking a long-term view, nothing has changed to modify the optimistic view of the economy. We still expect medium-term growth to be high."

With Seetha in New Delhi