Regulation and de-regulation of the stock market in India

In the early 1990s, policy changes in India led to the liberalisation and reform of capital markets and the establishment of a new stock market regulator, the Securities Exchange Board of India (Sebi). This paper attempts to assess the functioning of Sebi, drawing on theoretical principles of regulation as well as data on capital market indicators and on investigations and punitive actions by Sebi.

It argues that:

• regulatory and market microstructure reforms have so far been unable to revive Indian stock markets, because of periodic financial scams that damaged confidence in the regulator’s effectiveness; the industrial slowdown during 1997-2000; and shallow markets with little room for small investors
• although a large base of small investors was created in the 1970s, this base has been shrinking since 1997 in response to losses which were incurred due to market fluctuations and stock market scams
• the 2003 boom in stock markets was largely driven by foreign institutional investors; many domestic investors used the opportunity to liquidate their holdings and exit the stock markets; and changes introduced by Sebi, such as increases in small investor quotas, have not yet changed this situation
• surveillance technology and regulatory standards are at international levels, but implementation appears to be imperfect; small investors are still concerned about management fraud, lack of transparency, price manipulation and volatility, although the Sebi reforms of 2001 have improved the situation
• during 1992-2003, 657 attempts were made by Sebi to investigate and penalise fraudulent and unfair trading practices; but it has taken up to two years to settle a case, only 424 of these cases were completed; and the conviction rate has been low
• Sebi’s record in redressing grievances against brokers and collective investment schemes was poor before 1998 but improved afterwards: more cases are now investigated and penalties, which were previously very low, have been increased.

The paper predicts that, as growth revives and markets become more active, the tight norms established by Sebi will begin to pay off. However, it argues that there is still room for improvement in the regulatory framework. In particular, more space should be made for small investors, who tend to follow a buy and hold strategy and thus lend stability to the market.