Are Indian Derivatives Weapons Of Mass Financial Destruction?
India’s position now seems to be that we need Chinese products and Chinese companies to manufacture in India
On Episode 352 of The Core Report, financial journalist Govindraj Ethiraj talks to Ajay Bagga, veteran investor and market expert as well as Ajay Srivastava, founder of the Global Trade Research Initiative and former DGFT official.
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SHOW NOTES
(00:00) The Take
(04:21) Markets rise, so does oil
(05:59) India receives 9% more rainfall in July
(07:42) Toyota’s ₹20,000 crore manufacturing investment in Maharashtra
(08:38) Check out our new series Nasscom Conversations
(10:01) Sebi’s move to cool down a heated derivatives market. How and why
(21:44) In 3 years, Chinese exports to India jumped 56% from $65 billion to $102 billion. How did that happen?
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regards any feedback, you can drop us a message on [email protected].
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Good morning, it's the 1st of August, and this is Govindraj Ethiraj headquartered and broadcasting and streaming from Mumbai.
The Take
We have been discussing how many young people have been effectively gambling away their savings and borrowings in derivatives trading.
Last year, some 9.2 million individuals and proprietorship firms lost around Rs 52,000 crore in index derivatives of the National Stock Exchange.
Moreover, of some 9.2 million traders, some 8 million made losses, according to a report in the ET.
And then there are transaction costs which add to the Rs 52,000 crore figure .
Households are losing up to Rs 60,000 crore annually in the futures and options segment, said Sebi chairperson Madhabi Puri Buch, adding that this was a 'macro issue' in a public statement on Tuesday.
Which means it had larger economic implications and it also was a number large enough in context to talk about.
"If Rs 50,000-60,000 crore a year is going away into losses in F&O whereas that would have been productively deployed as may be the next IPO round, maybe MF, to other productive purposes, why is that not a macro issue?" Buch said at a NSE event in Mumbai, reported MoneyControl.
Buch had earlier as well said that the regulator is worried not only from a "micro-level," where the nature of F&O trading might put individual investors at risk, but also from a "macro-level," where it could potentially disrupt overall economic growth.
A study conducted by SEBI previously indicated that 90% of trades in the F&O segment resulted in losses.
In response, the capital markets regulator issued a consultation paper on Tuesday, proposing measures to curtail such activities.
India has the highest amount of derivatives trades in the world right now.
So, the ET report quoting Sebi shows that Rs 52,000 crore is over 32% of net inflows into the growth and equity oriented schemes of all mutual funds during FY24. It is also over 25% of the average annual inflows into all mutual funds across all schemes over the past five years.
These are large numbers.
Moreover, more than seventy percent of individual investors in the equity cash segment incurred losses in FY23, a study recently conducted by capital markets regulator Sebi had found.
There are several questions here, partly on how much derivatives trading do we really need and understanding its role.
While there are several steps announced that we will talk about shortly with Ajay Bagga, the fact is that we have to look at what is causing it and work on that too.
People, partly smaller and first time investors start speculating in stock markets because it of course has the allure of quick and easy money. And who does not like that ?
Equally, because they are trying to fight inflation with their steady or only steadily rising incomes. Or in some cases, maybe no other incomes.
We have to address both sides of the problem.
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Markets & Oil
Benchmark equity indices - the BSE Sensex and the NSE Nifty50 - ended Wednesday's session in positive territory. Sensex settled at 81,741, up 285 points or 0.35 per cent, while Nifty50 ended 94 points or 0.38 percent higher at 24,951.
Some 21 out of 30 stocks on the BSE Sensex gained with Maruti Suzuki India, JSW Steel, Asian Paints, NTPC, and others ending up to 4 per cent higher.
Maruti Suzuki, India’s largest car maker, also posted a 47% year-on-year increase in standalone profit for the June quarter, amounting to ₹3,650 crore, beating Street's estimates of ₹3,467 crore.
Quarterly revenue rose by 10 per cent from the same period last year to ₹35,531 crore, surpassing the estimated ₹34,565 crore.
More on auto shortly.
Meanwhile, the rupee dropped to a record low against the U.S. dollar on Wednesday, pressured by month-end dollar demand by importers, traders said.
The rupee declined to 83.74 to the dollar, reported Reuters.
Speaking of currencies, while we focus on dollars, do you know how the INR is faring against other currencies?
Well, the Pound Sterling is now at around Rs 107 per pound while the Euro is Rs 90 per Euro.
Meanwhile, the era of low oil prices right now, may just last a week. So perhaps era is not the right word.
Speaking of right words, India received 9% more rainfall than average in July as the monsoon covered the entire country ahead of schedule, delivering heavy rain in central and southern states, weather department data showed on Wednesday, reported Reuters.
This would also mean that we could stop now worrying, at least in most parts of the country, about the impact of delayed or less rainfalls.
The problem as we are seeing in states like Kerala is the opposite.
Too much rainfall in too short a time can trigger massive disasters leading to loss of life and property.
In July, southern and central regions of the country received nearly a third more rainfall than the average, while east and north-eastern regions received 23.3% less rainfall, according to the India Meteorological Department (IMD) quoted by Reuters.
The surplus rainfall in July helped erase June's rainfall deficit of 10.9%, and the country has received 1.8% more rainfall since the start of the monsoon season on June 1.
Oil Prices Jump
Oil jumped, extending an earlier gain, after Hamas said Israel killed its political leader, stoking tensions in a region that produces around a third of the world’s crude.
Brent crude is now quoting above $80 a barrel after falling 4.5% over the previous three sessions.
The reason is a reemergence of fresh tensions in the middle east after Hamas said Israel killed its political leader, Ismail Haniyeh, in an airstrike in Iran.
There has been an escalation in conflict since last weekend, reported Bloomberg.
Toyota Steps On The Gas
On the heels of Maruti’s strong results, well almost, Toyota Kirloskar Motor on Wednesday said it will set up a new manufacturing plant in Maharashtra at an investment of around Rs 20,000 crore.
The company has signed a Memorandum of Understanding (MoU) with the Maharashtra government to examine the setting up of a greenfield manufacturing facility at Chhatrapati Sambhaji Nagar, Toyota Kirloskar Motor (TKM) said in a statement reported by Business Standard.
Toyota’s move obviously reflects the automakers confidence in the Indian market and of course its own product mix and their growth.
Toyota’s hybrids have been flying off the shelves in the last few years and more so in recent months.
Toyoto is right now headquartered in Karnataka and already has two manufacturing units located at Bidadi near Bengaluru, which incidentally I visited a few years ago.
The statement also said that Toyota has invested more than Rs 16,000 crore and created close to 86,000 jobs in the entire value chain, it said.
Why Sebi And Others Are Worrying About Derivative Trading?
The Sebi has rolled out several proposals which are largely aimed at cooling the massive derivatives market.
The moves include curbing multiple option contract expiries and increasing the size of options contracts.
There are seven measures suggested by the market watchdog and aim to reduce market speculation apart from of course keeping trigger happy investors safer. To the extent they can be.
SEBI's proposals are made in light of increased retail participation, offering short-tenure index options contracts, and heightened speculative trading volumes in the index derivatives on expiry days.
What Sebi is also highlighting is that it is not something that is confined to a problem of some investors losing their shirts but also a situation that can set off a larger financial/banking problem or even mess.
Obviously because, as we have discussed earlier, people are often borrowing to trade.
I spoke with Ajay Bagga, veteran investor and began by asking him how to first define F&O and derivatives trading and then onto the links with the broader market.
INTERVIEW TRANSCRIPT
Ajay Bagga: Futures and options Govind are derivatives. And what does a derivative mean? It's something whose price is derived from an underlying. Now the underlying could be a stock listed on the exchange. It could be a commodity like gold, like silver, like some other metal, like iron ore or aluminum or copper, or it could be anything else, like a synthetic derivatives, as happened in 2008 during the global financial crisis, when the world had gone mad. So if you don't know about derivatives, I would suggest it's a very good and straight to begin and stay like that. Don't try to learn about it. Warren Buffett govin said the best quote on that. He says these derivatives are weapons of mass financial destruction, so the mayhem that they can cause is very huge. Why are derivatives used? You know, if you have a basic position in some asset, say a stock or a commodity or something else, you want to hedge, meaning you want to protect yourself against the movement in that price, then you can buy or sell the derivatives. So the derivatives price, it is quite complex. People have got noble price in economics for, say, devising the option pricing model, which is at the base of all this pricing that's out of our purview. We don't need to learn that. It involves a lot of abstruse calculations, but it moves in line with the underlying and there are what we call option Greeks, which you know, give you an idea of how much it will move, how much a change in the macro, like an interest rate change, how much would that impact the pricing of a derivative? So there's a lot of mathematics. There are a lot of high frequency traders go in who have huge machines, who are looking to make a few paisa on every trade and continuously, they have algorithms which are programmed, and those are running continuously, looking to buy and sell.
Govindraj Ethiraj: So let me pick up on the statement that SEBI chairperson made yesterday, which is that households are losing up to 60,000 crores annually in the futures and options segment. So now this figure has been contrasted with some other figures, including the net flows into mutual funds, and it appears to be almost 1/3 of that in the last year. But my larger question is, where are we now in terms of the manner in which this has expanded and grown, and secondly is the way prices move in the futures and options space is that affecting the main market.
Ajay Bagga: It is not affecting the main market. It's a derivative of the main market. But what happens is if too many people lose too much money. So right now govin, there are 93 lakh unique traders in our markets, 93 like unique pan have been identified who are trading in our market. So one out of every 140 Indian is on this market, which is a huge ratio. The risk is now the 60,000 crore number will need a lot of study, because there are people who genuinely hedge positions. Suppose you have a portfolio which is worth 50 lakhs, one crore, and you want to hedge against the chance of it going down 5% you go and buy what is called a put option, that in case the price goes down, I will be rewarded. So there are various strategies running in this market. I think if you had a 60,000 crore loss number, you would have much more noise. You get this anecdotal knowledge that somebody took the wives on them and sold them, or somebody mortgaged their house and lost everything. Or, as we had seen, if you remember, an automobile major at a foreign bank a few years back, 400 crores, a foreign bank, RM, and one or two other colleagues of theirs took the family office, money of an automobile major based in North India, and they lost 400 crores trading derivatives. The foreign bank made it up to that family, but that had become a very big issue. So I don't see the pain in the market of 60,000 crores. I will. Been lost again. I am an ivory tower sitting in my own cocoon. I don't meet hundreds of investors, but the investors I meet in investor camps are very successful people. So nine out of 10 Indians apparently, are making losses in this futures and options. Seven out of 10 are making losses in the cash equity segment, the cash price equity segment. So there should have been a lot more noise. I mean, it's nearly like a manrega budget has got lost in the market. I find it very strange, though it is true govin That there is a hedge fund called Jane Street, and they got into some trouble, and they had to make some court filings, and it came out that just one strategy of theirs in the Indian market had made them nearly one and a half billion dollars, or $2 billion over one year period, just one strategy, so there could be multiple strategies. So that is true. If somebody has lost 60,000 crores, it's not a zero sum exactly, but there will be profits. But I don't see that noise, but again, I'm not a representative sample, or a big enough sample,
Govindraj Ethiraj: Anyway, so let's put the figure aside. I think the statistics in terms of the number of people who are making losses, that's one second. I think if you correlate it with the fact that many of these people who are making losses are young, they're mostly below 30, which means they're logically, you know, have entered the markets only recently, and that obviously has its own set of problems, which may not affect the, let's say, the integrity of the market, but will surely affect them and their, let's say, financial positions, particularly if they've borrowed. So what's your larger sense? Ajay, you know, when investors look at the market, now, obviously derivatives, for whatever reason, or many reasons, appears lucrative and quick because you can day trade and you have the feeling of making quick money, whereas long term investment, or investing is a completely opposite strategy of that. So how would you suggest people should look at this and will all these moves by SEBI to cool things down help?
Ajay Bagga: Yeah, one is people don't try to get rich quick, because, you know, the fast money pays for the patient money. That's a truism of the market. The patient investors will take the money off you second. If you're a retail investors, you don't stand a chance against the institutional investors, who have huge computing power, who have professionals who are doing this 24 hours a day, and who have huge algos, algorithms, computer models, which are working to find out people like us and take our money from our pocket. So it's a mugs game trying to get rich quick, intense in disaster. Second, the danger in derivatives go in this that with one rupee you can actually have a position which is worth six to 10 rupees. You can get a lot of leverage, and that's where the issue comes, you know. So if you make a percentage wise loss, you can wipe out your entire capital, cash equities. Why seven out of 10 lose, because you can lose only your capital. So if you are down 2% you lose 2% of your capital in the derivatives. If you're down, say, 12 or 14% or 15% you might end up, you know, destroying your entire capital base. That is the risk. So these are very toxic, not meant for retail investors, not meant for the untrained investors. What happened with covid Govind, this Robin hooders breed grew all over the world. It's not only in India. It's a global phenomena where discount brokerages came in, who provided access these technical software came in. So you thought, looking at a few market you know, curves and market indicators, you became a market master. And there were various workshops and strategies being offered to the retail investors who thought that you will become, you will get rich and double your money on a daily basis, and you end up losing so it was a covid phenomena where gamification and it became like a video game. And also what happened is that it became a gambling casino. So the market became a casino that you come and bet every day and you take money. It's not a betting place. It works on fundamentals. In the end, it is based on corporate earnings and cash flows in the short term, whatever it might work on. That fundamental thing got lost out, covid. So. So it's not a good place for retail investors to be in, and they will lose money. Not even nine. I would say 9.99 times out of 10. Retail investors lose money in these markets. Corporates also lose huge money. You would remember the case of Orange County, where entire municipality went bankrupt. Corporates went bankrupt, and 2008 were 100 year old institutions worth $600-$800 billion of market cap, even brothers. Yeah. So that's why Buffett calls it weapons of mass financial destruction. They're not for you and me,
Govindraj Ethiraj: That's a very emphatic and good note to end on Ajay, thank you so much for joining me.
Ajay Bagga: Thank you.
Why India’s imports from China are skyrocketing
If you follow popular media, then you know that India has been waging a trade war against China, filing tax cases against Chinese companies, notably those making mobile phones and banning over 300 apps from Google PlayStore and Apple phones.
Tiktok is the most prominent of these apps which is not available in India now.
All this is in retaliation for the mischief that China has been upto at the roughly 3,500 km border that India shares with China.
So for all the high decibel media noise you would be right in thinking that trade between our countries is shrinking and we are steaming full speed towards a China + 1 strategy where companies move manufacturing capacity from China to India or add India as a backup and as a future investment.
Not quite, actually.
In the past 3 years, (during FY2021 and FY2024), India’s imports from China increased by 56%, from US$65.2 billion in FY2021 to US$101.8 billion in FY2024
On the other hand, India’s exports to China decreased by 21%, from US$21.2 billion in FY2021 to US$16.7 billion in FY2024
Some #china 1 investment is obviously happening. The most talked about or heard about is obviously Foxconn’s manufacturing in India for Apple iphones which are mostly exported.
Last year, Apple made $14 billion worth of phones in India or 14% of total production with exports crossing $10 billion.
The phones are made in vast factories mostly in Tamil Nadu.
India’s position now seems to be that we need Chinese products and Chinese companies to manufacture in India.
I reached out to Ajay Srivastava, former DGFT official who now runs the Global Trade Research Initiative in New Delhi and began by asking him how the numbers had jumped so significantly.
INTERVIEW TRANSCRIPT
Ajay Srivastava: Imports from China increasing, and the root cause is that we are very much dependent, almost critically dependent, on China for our industrial product imports. And if I divide industrial products into eight categories, machinery, electronics, chemicals, pharmaceuticals, textiles, garments, etc, then each of these eight categories, China is number one import supplier to us in each of these. So the general perception is that China is good in electronics. They are supplying a sort of electronics, some machinery, some capital goods. But no, it's amazing that they are number one import supplier in all the categories. That's how we lost the space in the past 20 years. If you recall, in about year 2000 to 2003 the data with China submitted to WTO, it showed that India and China had equal trade. In fact, India was having some minor surplus. But since then, China has taken off. And were our reports have gone up. So overall imports in industrial products, 30% comes from China,
Govindraj Ethiraj: And of the total trade of $118 billion with China, that's bilateral, imports are about 100 and 2 billion. So we're only exporting about 16 billion.
Ajay Srivastava: Yes, ports are stagnant for the past almost five years, but imports are jumping
Govindraj Ethiraj: So now there are two parts to this. So there is obviously a geopolitical shift that has taken place, which I'm not focusing on so much, but the two parts is, one is that we are importing products, and secondly, we also seem to be now open to more Chinese investment, driving manufacturing locally. So how are you seeing this play out?
Ajay Srivastava: In fact, this was said for the first time in the economic survey. They said that the precise wording is this. They said that India should welcome investment from China so that we can manufacture and export things and export them to US and European Union, the way Mexico and Vietnam and South Korea are doing. But if you look at this, this is not workable. You know, large chance of Trump coming back to USA in March this year only. He noticed that how China is going to Mexico and other countries setting up shops there, plants there, and trying to supply to us. So he is specifically warned Chinese automakers. He said, If you are coming to Mexico and want to supply to us as we are scaling the trade war in a big way. So how can we take such a risk? It's our preamble that we want Chinese investment for manufacturing, yes, for supplying to us. It's not going to work. And second, forget about the Trump's reaction. What's our policy? You know, China is a big country, and we need considered policy. And India has a considered policy, even though reports are increasing, but we have, we were grudgingly acknowledging that imports increasing, we should do something. PLI was an attempt in this direction. But not only that, we wanted to reduce dependence on China a number of ways. For example, we are negotiating. We signed three pillars of Indo Pacific economics framework. It's a setup almost like an FDA led by us and 14 more countries to shift our supply chains away from China. Then we have joined supply chain resilience conditions initiative with the US, Japan, Australia, etc, two to find alternate supply chains, alternate to China. So this hint from economic survey, it was a surprise to people like me. We thought we are going away from our policy. And if you follow this policy, there will be large scale contradictions. How you explain you are joining IPF also in you are inviting Chinese investments also.
Govindraj Ethiraj: So as you look forward, how do you see imports now making India more competitive, perhaps, for example, in the case of iPhones, the fact that we are able to import, let's say, the raw materials or the input components at a lower cost, obviously makes things easier for us because we've reduced import duties. I mean, that's one example. There could be many others. So all in all, how do you see this playing forward the fact that we are now more open to Chinese imports, particularly, I'm sure, at lower cost as well.
Ajay Srivastava: You took the example of smartphones, not too happy with that, because for high end smartphones, the valuation would be less than 10% and so we are not importing Even the companies were importing sub assemblies, and we are putting sub assemblies together into making smartphone and sending it abroad. So import content could be very high in such things. There is no deep manufacturing in India. So tomorrow, the people who are manufacturing a smartphone, they shut shop and go, we have not learned anything. We don't know the technology of making itself. So unless we focus on, say, component making, we focus on deeper manufacturing, we are nowhere, and each country be South Korea or China, Japan, they all did this the hard way. For example, Japan in their 60s and 70s, they emulated American technology by reverse. Engineering everything, opening the cars and then reassembling learning by China, copied both Japan and Taiwan and USA. Everybody does that way. So I want to highlight this, that if we divide all the benefits and send two very broad, simplified parts, one is high tech, and second is not so high tech. Not so high tech. Most of the products, they can be reverse engineered. But India, we talk a lot, but the field level we need to do seriously how we can promote reverse engineering of the products. We're not very high tech technologies required, or buy new technology required. About the high tech, it's a hard way we were to invest in R&D. It will take 2030, years. It took that amount of time to Japan, Korea, everywhere, Germany, every year, and we should be willing to invest that time for future. And this is the only way. There is no simplistic way to promote manufacturing. We are doing brand aid in the name of most of the manufacturing. I think we need to change our thinking and think long term, think deep.
Govindraj Ethiraj: If you look at light engineering, or not so high tech, as you said. Now, I mean, I think many people have tried it, but for various reasons, it's not succeeding. I'm assuming because also we are uncompetitive at some levels. I mean, for example, let's say maybe cost of energy, or there may be other subsidies, implicit subsidies, in the way Chinese companies are manufacturing, but the PLI scheme was one step to counter that. Now it is working to some extent. There's no doubt about that, but perhaps not to the extent that we need if we are trying to counterbalance, let's say, Chinese imports. So in a broad sense, how do you then see the way forward?
Ajay Srivastava: I totally agree with you. We are having high cost of doing business. Our interest rates are high. Cost of capital is high, and power is not UPS uninterrupted power is missing in many places, people have to put their own power supplies all these things that increase the cost. There is no other way but to address this. We cannot address this immediately, but we have to address this sector by sector. There is no other way. If we study how all these countries, from Germany to France to South Korea to Japan, they have grown up. We have to strengthen our fundamentals. We have to strengthen the fundamentals. We cannot just be taking care of the outer part. We just cannot be importing everything and putting in a box and exporting and be happy about this. There is no other manufacturing the long term game. We think it should be done in two years time, three years time, no, no way. But as I say, for 90% of products, reverse engineering the way, let's try doing it, and imports will continue. You know, override makers don't happen. Will not happen in this case also, but at least I say, even if we are not succeeding, let's get our recipe right. Let there be a deeper discussion at the national level, what is the recipe? The current thing is importing everything, putting a box, and it's porting is not a recipe. So first we need to have a understanding of what is the best recipe, and then work on it. It will take time.
Govindraj Ethiraj: Mr. Srivastava, thank you so much for joining me.
Ajay Srivastava: Thanks Govind, thanks for inviting me. Thank you.
