Market falls due to Balance of Payment crisis ('90-91)

During 1980's India registered higher growth compared with 70's due to policy of industrialization. This growth came with higher fiscal deficit, current account deficit and huge external debt with poor foreign exchange reserve. GDP per capita statistics Franklin Templeton MF
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Editorial

In current challenging investment environment where investors are worried and clueless about their investments this booklet is an attempt on part of NJ India to provide insight into the behavior of equity market in bear phase. The objective of this attempt is to make sure that our esteemed investors take rational and informed decisions in current challenging environment. In the current scenario where investors are trying to find direction for their investment, we have tried to study instances where market had fallen more than 40% and how market had performed after these steep falls. If we peep into the history of SENSEX, there are ample instances when market had fallen more than 40%; be it fall of BOP crisis of 1990-91 or stock market scam of Harshad Mehta or recent fall of 2004 when NDA lost elections, reasons may be different behind all these falls but we come across only one conclusion from this fall and that is market has always strongly bounced back from steep fall. Every market fall had provided opportunity to investors to invest and market has always rewarded rational investors who had captured this opportunity and stayed invested for reasonably long period of 3 to 5 years. Apart from bear market scenario analysis, we have in this book also tried to study how market has returned from bear market bottom and from 15% above market bottom level, as we all know it is impossible to catch the absolute bottom. Even from 15% above bottom level, market has delivered above 15% return for three-year duration in all occasions except one. We at NJ India have always given high importance to SIP route of investment, as we believe it can reduce investment risk due to rupee cost averaging. This is again proved correct if we look at the SIP return of equity schemes in 2008 against return of lump sum investment. And finally, we all know current valuations are mouth watering as far as Indian equity markets are concerned and many of us are worried about future course of action particularly those who have invested at near market pick level of around 20000. From current EPS level, even if earning grows at 15% in next five years SENSEX can easily cross 20000 level and scale new highs as it is shown in our 'Expected Market Level' analysis page. This book is an attempt from NJ India Invest to share some interesting insights about our equity markets, to keep our esteemed investors informed about market behavior and to help them to take rational investment decisions to create wealth.

During 1980's India registered higher growth compared with 70's due to policy of industrialization. This growth came with higher fiscal deficit, current account deficit and huge external debt with poor foreign exchange reserve. It was a period of tight and restricted FDI & FII policy. External payment regime was tightly controlled; transaction cost of remitting money through official channel was high. Money got remitted through 'Hawala' market transactions. There was external shock in terms of Gulf War between Iraq and Kuwait that resulted in spike in crude oil prices that jumped by 91% in one year. Political uncertainty of 1989-90, Mandal Commission and OBC reservation, falling of V.P.Singh government and General Elections in 1991 put pressure on stock markets. Balance of Payment (BOP) crisis hit India in 1990-91 and India came on the verge of external debt default. This led to SENSEX fall of close to 40% from September 1990 to April 1991 and SENSEX went below 1000 points. From that level market had given CAGR of 61% for three-year duration in spite of the fact that we witnessed Harshad Mehta scam in the same period.

What Harshad Mehta did? The Stock Scam

In the early 1990s, the banks in India had to maintain a particular amount of their deposits in government bonds. This ratio was called SLR ( Statutory Liquidity Ratio). Each bank had to submit a detailed sheet of its balance at the end of the day and also show that there was a sufficient amount invested in government bonds. Now, the government decided that the banks need not show their details on each day, they need to do it only on Fridays. Also, there was an extra clause that said that the average %age of bond holdings over the week needs to be above the SLR but the daily %age need not be so. That meant that banks would sell bonds in the earlier part of the week and then buy bonds back at the end of the week. The capital freed in the starting of the week could then be invested. Now, at the end of the week many banks would be desperate to buy bonds back. This is where the broker comes in. The broker knew which bank had more bonds (called plus) and which has less than the required amount (called short). He then acts as the

middleman between the two banks. Harshad Mehta was one such broker. He worked as a middle man between many banks for a long time and gained the trust of the banks senior management. Lets say that there are two banks A (short) and B (plus). Now what Harshad Mehta did was that he told the banker at A that he was dealing with many banks and hence did not know who would he deal in the end with. So he said that the bank should write the cheque in his name rather than the other bank (which was forbidden by law), so that he could make the payment to whichever bank was required. Since he was a trusted broker, the banks agreed. Then, going back to the example of bank A and B, he took the money from A and went to B and said that he would pay the money on the next day to B but he needed the bonds right now (for A). But he offered a 15 % return for bank B for the one day extension. Bank B readily agreed with this since it was getting such a nice return Now since Harshad Mehta was dealing with many banks at the same time he could then keep some capital with him at all times. For eg. He takes money from A on Monday,
Now since Harshad Mehta was dealing with many banks at the same time he could then keep some capital with him at all times. For eg. He takes money from A on Monday,and tells B that hell pay on Tuesday, then he takes money from C on Tuesday and tells D that hell pay on Wednesday and the money he gets from C is paid to B and as a result he has some working capital with him at all times if this goes on with other banks throughout the week. The banks at that time were not allowed to invest in the equity markets. Harshad Mehta had very cleverly squeezed some capital out of the banking system. This capital he invested in the stock market and managed to stoke a massive boom. Read Indian Stock Market Articles He took the price of ACC from 200 to 9000.Thats an increase of 4400%!!!The market went up like crazy and the bulls were on a mad run. Since he had to book profits in the end, the day he sold was the day when the market crashed. The same day Vijaya Bank chairman committed suicide by jumping from the top of the banks office. The chairman knew that when it would become public that he had written cheques in the name of Mehta, he would be dead meat. One rather unknown fact about this scam is that there was a very important player in this scam who

managed to keep a very low profile. That man was Nimesh Shah. He was just as involved as Harshad Mehta but he knew how keep out of the hands of the law. Nimesh Shah still deals in the stock market and is known to be a heavy player. Harshad Mehta is now dead. It is rumored that when he died, he still had 10% of ACC shares with him.

Harshad Mehta & Ketan Parekh Scam

Harshad Mehta: the high-profile stockbroker Harshad Shantilal Mehta (1954-2002) was an Indian stockbroker who grabbed headlines for the notorious BSE security scam of 1992. Born in a lower middle-class Gujarati Jain family, Mehta spent his early childhood in Mumbai where his father was a small-time businessman. The family relocated to Raipur in Chhattisgarh after doctors advised Mehtas father to shift to a drier place on account of his health. Transition from an ordinary broker to Big Bull Mehta studied in Holy Cross Higher Secondary School, Byron Bazar, Raipur. He quit his job at The New India Assurance Company in 1980 and sought a new one with BSE-affiliated stockbroker P. Ambalal before going on to become a jobber on the BSE for stockbroker P.D. Shukla. In 1981, Mehta became a sub-broker for stockbrokers J.L. Shah and Nandalal Sheth. Having gained considerable experience as a sub-broker, he teamed up with his brother Sudhir to float a new venture called Grow More Research and Asset Management Company Limited. When the BSE auctioned a brokers card, the Mehta duos company bid for it with the financial support of J.L. Shah and Nandalal Sheth. Another name that is rumored to have a crucial hand in the scam was Nimesh Shah. However, Shah could keep a safe distance from the accusations and is currently known to be a heavy player in the Indian stock market. By year 1990, Mehta became a prominent name in the Indian stock market. He started buying shares heavily. The shares of India's foremost cement manufacturer Associated Cement Company (ACC) attracted him the most and the scamster is known to have taken the price of the cement company from 200 to 9000 (approx.) in the stock market implying a 4400% rise in its price. It is believed that It was later revealed that Mehta used the replacement cost theory to explain the reason for the high-level bidding. The replacement cost theory basically states that older companies should be valued on the basis of the amount of money that would be needed to create another similar company. By the latter half of 1991, Mehta had come to be called the Big Bull as people credited him with having initiated the Bull Run. The making of the 1992 security scam Mehta, along with his associates, was accused of manipulating the rise in the Bombay Stock Exchange (BSE) in 1992. They took advantage of the many loopholes in the banking system and drained off funds from inter-bank transactions. Subsequently, they bought huge amounts of shares at a premium across many industry verticals causing the Sensex to rise dramatically. However, this was not to continue. The exposure of Mehta's modus operandi led banks to start demanding their money back, causing the Sensex to plunge almost dramatically as it had risen. Mehta was later charged with 72 criminal offences while over 600 civil action suits were filed against him. Significantly, the Harshad Mehta security scandal also became the flavor of Bollywood with Sameer Hanchate's film Gafla. The 1992 security scam and its exposure Mehta's illicit methods of manipulating the stock market were exposed on April 23, 1992, when veteran columnist Sucheta Dalal wrote an article in India's national daily The Times of India. Dalals column read: The crucial mechanism through which the scam was effected was the ready forward (RF) deal. The RF is in essence a secured short-term (typically 15-day) loan from one bank to another. Crudely put, the bank lends against government securities just as a pawnbroker lends against jewelers. The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher

price. In a ready-forward deal, a broker usually brings together two banks for which he is paid a commission. Although the broker does not handle the cash or the securities, this was not the case in the prelude to the Mehta scam. Mehta and his associates used this RF deal with great success to channel money through banks. The securities and payments were delivered through the broker in the settlement process. The broker functioned as an intermediary who received the securities from the seller and handed them over to the buyer; and he received the check from the buyer and subsequently made the payment to the seller. Such a settlement process meant that both the buyer and the seller may not even know the identity of the other as only the broker knew both of them. The brokers could manage this method expertly as they had already become market makers by then and had started trading on their account. They pretended to be undertaking the transactions on behalf of a bank to maintain a faade of legality. Mehta and his associates used another instrument called the bank receipt (BR). Securities were not traded in reality in a ready forward deal but the seller gave the buyer a BR which is a confirmation of the sale of securities. A BR is a receipt for the money received by the selling bank and pledges to deliver the securities to the buyer. In the meantime, the securities are held in the sellers trust by the buyer. Complicit lenders Armed with these schemes, all Mehta needed now were banks which would readily issue fake BRs, or ones without the guarantee of any government securities. His search ended when he found that the Bank of Karad (BOK), Mumbai and the Metropolitan Co-operative Bank (MCB) two small and little known lenders, were willing to comply. The two banks agreed to issue BRs as and when required. Once they issued the fake BRs, Mehta passed them on to other banks who in turn lent him money, under the false assumption that they were lending against government securities. Mehta used the money thus secured to enhance share prices in the stock market. The shares were then sold for significant profits and the BR retired when it was time to return the money to the bank. Outcome Mehta continued with his manipulative tactics, triggering a massive rise in the prices of stock and thereby creating a feel-good market trajectory. However, upon the exposure of the scam, several banks found they were holding BRs of no value at all. Mehta had by then swindled the banks of a staggering Rs 4,000 crore. The scam came under scathing criticism in the Indian Parliament, leading to Mehta's eventual imprisonment. The scams exposure led to the death of the Chairman of the Vijaya Bank who reportedly committed suicide over the exposure. He was guilty of having issued checks to Mehta and knew the backlash of accusations he would have to face from the public. A few years later, Mehta made a brief comeback as a stock market expert and started providing investment tips on his website and in a weekly newspaper column. He worked with the owners of a few companies and recommended the shares of those companies only. When he died in 2002, Mehta had been convicted in only one of the 27 cases filed against him. What attracted the taxmans attention was Mehta's advance tax payment of Rs 28-crore for the financial year 1991-92. Another eye-catcher was his extravagant lifestyle. I-T, PSBs recover dues nine years after Mehta's death Nine years after Harsad Mehta died, the I-T department and public sector banks (PSBs) have successfully recovered a significant portion of their claims emerging out of the securities scam from his liquidated assets. The Supreme Court directed the Custodian of the attached properties and assets of the Harshad Mehta Group (HMG) in March 2011 to make payments of Rs1,995.66-crore to the I-T department and Rs 199.25-crore to the State Bank of India (SBI), making the two institutions two of the earliest claimants to recover their dues. While the SBIs total principal amount claim of Rs 1,000-crore have been largely settled, financial institutions have also received some money. However, Standard Chartered Bank, which had claimed Rs 500-crore, has yet to recover its dues it was one of the late claimants. Although the total claim over the HMG is of more than Rs 20,000-crore, the apex court has said that for the present, it would only consider claims towards the principal amount. Who is Ketan Parekh Ketan Parekh is a former stockbroker based in Mumbai who was convicted in 2008 for being involved in engineering the technology stocks scam in Indias stock market in 1999 -2001. A chartered accountant by training,

Parekh comes from a family of brokers and is currently serving a period of disqualification from trading in the Indian bourses till 2017. Ketan Parekh has been accorded with sobriquets such as the Pentafour Bull and the One Man Army by the countrys national business newspapers, while the market simply refers to him as KP or associates him with his firm NH Securities. Parekh is known to have no reluctance in meeting the press. He is also known to have razorsharp forecasts on market developments. What distinguishes Ketan Parekh from the 'Big Bull' late Harshad Mehta The two have been compared by people to have operated their scams using similar means and that their backgrounds were similar as well. But the differences are very conspicuous. At the outset, Mehta came from a lower middle-class and modest background, while KPs family has been engaged as stockbrokers for a significant time. He is also related to many prominent brokers. Secondly, when Mehta was operating, the market was still a closed one and was just beginning to liberalize. It was revealed later that Mehta operated using the money of other people as his last recourse. Further, Mehta is known to have resorted to aggressive publicity campaigns whereas KP operates almost clandestinely. The latter has also been successful at creating stories and selling them aggressively to institutional investors. The Midas touch Parekh attracted the attention of market players and they kept track of every move of Parekh as everything he was laying his hands on was virtually turning into gold. But the Pentafour Bull still kept a low profile, except when he hosted a millennium party that was attended by politicians, business magnates and film stars. And by 19992000, as the technology industry began embracing the entire world, Indias stock markets started showing signs of hyper-activity as well and this was when KP struck. Almost everyone, from investment firms which were mostly controlled by promoters of listed companies to foreign corporate bodies and cooperative banks were eager to entrust their money with Parekh, which, he in turn used to inflate stock prices by making his interest obvious. Almost immediately, stocks of firms such as Visual soft witnessed meteoric rises, from Rs 625 to Rs 8,448 per unit, while those of Sonata Software were up from Rs 90 to Rs 2,150. However, this fraudulent scheme did not end with price rigging. The rigged-up stocks needed dumping onto someone in the end and KP used financial institutions such as the UTI for this. When companies seek to raise money from the stock market, they take the help of brokers to back them in raising share prices. KP formed a network of brokers from smaller bourses such as the Allahabad Stock Exchange and the Calcutta Stock Exchange. He also used BENAMI or share purchase in the names of poor people living in Mumbais shanties. KP also had large borrowing s from Global Trust Bank and he rigged up its shares in order to profit significantly at the time of its merger with UTI Bank. While the actual amount that came into Parekh's kitty as loan from Global Trust Bank was reportedly Rs 250 crore, its chairman Ramesh Gelli is known to have repeatedly asserted that Parekh had received less than Rs 100 crore in keeping with RBI norms. Parekh and his associates also secured Rs 1,000-crore as loan from the Madhavpura Mercantile Co-operative Bank despite RBI regulations that the maximum amount a broker could get as a loan was Rs15-crore. Hence, it was clear that KPs mode of operation was to inflate shares of select companies in collusion with their promoters. Lady luck disfavours Parekh! Notably, a day after the presentation of the Union Budget in February 2001, Parekh appeared to have run out of luck. A team of traders, Shankar Sharma, Anand Rathi and Nirmal Bang, known as the bear cartel, placed sell orders on KPs favorite stocks, the so called K-10 stocks, and crushed their inflated prices. Even the borrowings of KP put together could not rescue his scrips. The Global Trust Bank and the Madhavpura Cooperative were driven to bankruptcy as the money they had lent Parekh went into an abyss with his reportedly favourite K-10 stocks. The exposure of the dupe As with the Harshad Mehta scam, Ketan Parekh's fraudulent practices were first exposed by veteran columnist Sucheta Dalal. Sucheta's column read, It was yet another black Friday for the capital market. The BSE sensiti ve index crashed another 147 points and the Central Bureau of Investigation (CBI) finally ended Ketan Parekhs two year dominance of the market by arresting him in connection with the Bank of India (BoI) complaint. Many people in the market are not surprised with Parekhs downfall because his speculative operations were too large, he was keeping dubious company, and he was dealing in too many shady scrips.

When the prices of select shares started constantly rising, innocent investors who had bought such shares believing that the market was genuine were about to stare at huge losses. Soon after the scam was exposed, the prices of these stocks came down to the fraction of the values at which they had been bought. When the scam did actually burst, the rigged shares lost their values so heavily that quite a few people lost their savings. Some banks including Bank of India also lost significant amounts of money. Dalal goes on to state that Parekh's scheme was not visible to a layman given the positive deflection that media had made him a hero while some of the biggest national dailies had even quoted him profusely on that years Union Budget. Dalal added that KPs arrest and the uncanny similarity of his operations to the Harshad Mehta securities scam of 1992 vindicated the miserable inadequacy of the countrys regulatory system. The Securities Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) had remained complacent when the stock bubble was created during the latter half of 1999 and through 2000 while it had not bothered to take any action through 2001 when it was ready to burst. SEBIs damage control measures SEBI investigations into Parekh's money laundering affairs revealed that KP had used bank and promoter funds to manipulate the markets. It then proceeded with plugging the many loopholes in the market. The trading cycle was cut short from a week to a day. The carry-forward system in stock trading called BADLA was banned and operators could trade using this method. SEBI formally introduced forward trading in the form of exchange-traded derivatives to ensure a well-regulated futures market. It also did away with broker control over stock exchanges. In KPs case, the SEBI found prima facie evidence that he had rigged prices in the scrips of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek Infosys and Padmini Polymer. Furthermore, the information provided by the RBI to the Joint Parliamentary Committee (JPC) during the investigation revealed that financial institutions such as Industrial Development Bank of India (IDBI Bank) and Industrial Finance Corporation of India (IFCI) had given loans of Rs 1,400 crore to companies known to be close to Parekh. Criticism of SEBI Some of the regulatory actions SEBI undertook came under scathing criticism from some quarters who accused it of still being clueless about its supervisory duties. Observers said the regulator still continued believing that its only priority was to prevent a fall in stock prices. It was rumored that SEBI banned short sales and increased margins creating a virtual cash market in the process and squeezed turnover to a sixth of the normal level. It also fired all broker directors from the Bombay Stock Exchange and Calcutta Stock Exchange and declared the completion of three controversial settlements of the Kolkata bourse by retaining a sizeable proportion of the payout of operators who had allegedly tied-up for collusive deals. Furthermore, SEBI rounded up the bear operators and launched an inquiry into their alleged short sales. Stringent regulatory measures follow Parekh episode Parekh's fraudulent operations motivated the authorities to take necessary steps that have made made India's stock markets relatively safer in present times. He can also be credited for having forced indolent policy-makers to bring about reforms in the financial system. An active trader According to an Intelligence Bureau report, though disbarred from trading in the countrys bourses until 2017, is still operating in the markets through conduits, vindicating Dalal Streets belief that he has never left the market. The report says that as recently as December 2010, KP has been rallying behind different stocks and placing some of them at rigged up prices to large institutions such as the LIC. He is operating through little-known investment firms, market operators and a following of loyal brokers. KP, who was at the forefront during the technology shares-led bull run in 1999-2000, is apparently using front entities such as Orchid Chemicals , GMR Infrastructure, Cairn India, Deccan Chronicles Holdings, Reliance Industries, Punj Lloyd, Indiabulls Real Estate, Pipavav Shipyard, Amtek Auto, Hindustan Oil Exploration, UCO Bank, State Bank of India, EIH and JSW Steel, among others, to trade in shares. The report further states that KP has been instrumental in inflating the share price of SKS Microfinance from Rs850 to Rs1,100 following its listing in August 2010. He has also rigged IPOs of little known companies by buying out 50% of the issue in collusion with his Kolkata-based associates. KP and his associates have also

acquired very large positions in petroleum companies such as ONGC and HPCL, according to the report. An IB official has further said that KP and his team have revealed to their close associates that they have insider information on the government's proposal to decontrol the sale of gas which is expected to raise profit margins of these companies by about 20%.