No Monday market will be watched as closely as today’s. India'spolicymakers will be watched too. They have done well so far. But volatile times induce error. So let’s note that one of the most remarkable facts this crisis has shown is that the global stock market can absorb a trillion dollar loss in one day while the global banking system cannot absorb the same loss over two years. This is demonstration of the importance of a market-dominated financial system. A large banking system is a strategic vulnerability, particularly after taking into account the toxic interplay between banking and politics which can lead to loan waivers, loans to cronies, bailouts, resource pre-emption by the government, directed credit and PSU banks. A market dominated financial system is safer in that the worlds of finance and politics are much more likely to be kept apart.
In Russia, Indonesia, Ukraine, Hungary, Pakistan, etc., the stock markets have closed down for some period of time in this crisis. Regulators in the US and the UK lost their nerve, and did some silly things on short selling, which were reversed in a few days. In India, the fundamental attributes of a sound market have been satisfied. In the worst of pain—on Friday evening—there were both buyers and sellers on the screen. On Friday, the top three derivatives at NSE were Nifty (Rs 34,000 crore), rupee-dollar (Rs 976 crore) and ICICI Bank (Rs 947 crore). At closing time on Friday, on the near month ICICI Bank futures, there were buyers at the top five prices for 6,825 shares and sellers at the top five prices for exactly the same amount. There was no payments crisis, despite substantial price fluctuations. The market was working as it should: providing a venue for both positive and negative views to be expressed, and solving out for an equilibrium price. The policy establishment in India has fared well in this crisis. Knee jerk proposals for banning short selling have been rejected; RBI responded with alacrity by cutting CRR; Sebi plodded onwards with structural reforms by rescinding the mistakes about PNs made in October 2007. Last week was a trial by fire, and India’s exchanges, and the economic policy leadership, has come out looking good by international standards. Now the immediate task lies in rapidly solving the liquidity squeeze by setting up a proper operating framework for monetary policy, and undertaking fundamental reforms of the FII framework.