To market, to market

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: In December 1996, US Federal Reserve Chairman Alan Greenspan raised the concern that stock prices had been unduly lifted by “irrational exuberance”. The US government acted swiftly, banning stock market trading until speculation had been eliminated.

Of course, that response never happened. Nor did the US regulators ban programme trading and stock index futures after the Black Monday crash of October 1987, nor hedge funds after the collapse of Long Term Capital Management in 1998. The presumption behind regulatory responses in such cases is the correct one—namely, that markets generally improve information flows, and allow more efficient decision-making, including better risk management. When markets or market participants behave badly, specific problems are identified and addressed, whether they pertain to individual market participants, the mechanisms of trading and general rules of the game, or the manner of regulatory oversight.

In India, we often have a hard time even getting started. The official excuse for not permitting many kinds of markets is that they will behave badly, and permit exploitation and manipulation. This attitude, of course, is completely as odds with the stated policy aims of developing the Indian financial sector into a world-class competitor. In many cases, there is enough international and domestic experience with market design to proceed quickly with setting up and running the requisite markets.

Rupee currency futures are a good example of tardiness on the part of policymakers. The RBI responded to the June 2007 start of trading of rupee futures on the Dubai Gold and Commodities Exchange by setting up a committee on the matter. There is really nothing much to mull over in terms of market design, since the technology and institutional rules are off-the-shelf products. There are two possible objections to consider, however. The first comes from current dealers, who might see their profits from a non-transparent market with entry barriers squeezed by an open exchange. This concern is often disguised as one about volatility or market stability. In fact, competition from places such as Dubai is going to affect these incumbents anyway, and market-making rewards are going to migrate overseas. The second concern has to do with currency management. The RBI has followed a policy of managing the level and volatility of the exchange rate, especially with respect to the US dollar. Would currency futures make the RBI’s job harder?