US financial crisis : A lesson for India

Looking back at the heydays of the Indian stock exchange, it's not news to the quintessential investor that derivatives were being seen as the next big thing after shares. However, since the recession in January, practically everything has fallen down, leaving little choice to any investor. The recent US debacle has also had its impact on stock exchanges around the world. However, while the former is of prime concern to us, we can also learn a lot from the latter. India's chief economist, Arvind Virmani, is of the opinion that India should take heed from the US situation and encourages investors to only invest in derivatives that are exchange traded. In his own words, “You have to be cautious. Say, for example, when derivatives are mentioned, the implication to me is that you should try and first open up derivatives which are exchange- traded because those are much more transparent.” For those of you who don't know, there are basically two groups of derivative contracts in India, Over the Counter (OTC) and exchange traded. OTC refers to a situation when contracts are traded between two parties directly with/without the use of an intermediary and without going through an exchange, while exchange-traded derivatives, as the name suggests, are traded on an exchange.

He further added that even if some people do lose out on certain derivatives, it could at least solve the purpose of others getting educated about staying away from the same. Relating this situation to the US situation is not a hard task. Even in the States, the structure of deals was a very complex one, with the common public clueless about what is happening. Analysts point out that the sub-prime crisis in the US went on to such a magnanimous scale primarily because lenders as well as sub-prime housing borrowers sold their portfolio through complex derivatives to other players, hence making it unclear as to what would be the size of losses to individual firms in case of a financial crisis.

According to an article in the Economic Times, the RBI and SEBI have recently permitted exchange traded currency futures, initially in a rupee-dollar pare, and are expected to allow exchange-traded interest rate futures by December-January. Further, there are certain OTC derivatives also in the interest rate and currency futures categories. I firmly believe that it is high time now that the government steps in with some regulatory measures to monitor derivatives, since we, as a country, can surely not afford another economic crisis at this stage.