COMMENTARY

Share Markets Crash The Manufactured Crisis

As the second anniversary of UPA government approached, it was clear that a correction in the markets was overdue as the markets had reached dizzying heights in the last 1 year. Still it was shocking that investor wealth of Rs. 2.5 Lakh crore was wiped out in 2 days of trading last week. At the time of this writing, on the morning of 22nd May, trading has been suspended in the stock market with Sensex crashing by 1,000 points as traders and investors are gripped by panic. 'Blood bath' continues on the bourses as there are rumours that many brokers will not being able to honour their payments leading to a major payment crisis. The crash came with a meltdown in commodity prices in London , where copper and almunium prices fell sharply last week. Interest rates in US have also been tightening. Thanks to globalization both these factors triggered the fall all over Asia including India though it was India that bore the brunt.

However, what has long been sought to be papered over in the big stories about bright long term prospects of Indian economy was also exposed in the process - The hold of FIIs in the Indian stock market.

Around the time Asian markets were down, the CBDT put up a revised draft of its 1989 guidelines on distinction between trader and an investor in shares on its website inviting public comments. New proposals would have codified priniciples laid down by the judiciary in recent years on subject. An entity pays only 10 per cent tax on short-term capital gains, instead of 41 per cent tax, if it is treated as trader. FII claim to be traders on the dubious ground that they have no permanent residence in India . So even while FIIs derive huge gains through trading in the Indian stock markets they are not be subjected to tax even to limited extent that the CBDT circular indicates. The circular was largely seen by FIIs as a step to plug tax avoidance by them. This resulted in the exodus of FII money and a crash in the market. This had a worried Finance Minister publicly assuage FII sentiments by reassuring them that they would not be taxed.

Herein lies the rub. The artificially high share prices were a result of a favorable tax regime of the current Government for the corporates. There is no tax on long- term capital gains or even dividends. Most of the FIIs do not pay tax on the hefty profits they earn. And dependence of our share market on FIIs was brutally exposed once the FIIs decided to pull the plug. Most of these FIIs are registered in Mauritius , with whom we have a Double Tax Avoidance Treaty (DTAA). In fact the Parliament has abdicated its treaty making power to executive. Under Section 90 of Income Tax Act these powers have been delegated to executive * which does not even discusses these is parliament.

Even though no apparent scam or manipulation of prices has been detected this time around (except for a small IPO scam) till now, greedy promoters had devised ways to cash in on the euphoria generated by high stock exchange and give a pasting to retail investors. A slew of IPOs were on the offering (DLF, Deccan Airways etc.) to the public at high premium. A host of Mutual Funds also had started new schemes and collected money from public by offering units at NAV (thereby creating an illusion that they were making a cheap offer compared to existing MFs). And a soaring stock market had a similar effect on realty market where property rates went so high that they were out of reach of genuine investors. Real estate and construction companies planned to raise funds on the basis of absurd valuations. But the pattern of fluctuations over a few days clearly indicates that an organised lobby of speculators is taking the small-scale investors for a ride. The small investors sell at lower prices and the speculators buy. The FIIs withdraw and then again buy at lower prices. This is a manufactured crisis indeed.