What spooked the Indian markets yesterday?

NSE Nifty-50 India June 20, 2011

Yesterday, Indian markets tanked in the first session. Look at the adjoining chart of Nifty, which is broader 50 stock index and more liquid. Popular media identified the reason as renegotiation of a tax treaty between India and Mauritius. I don't believe it. I think this is an example of retrofitting explanations. 

First, look at the reason. Tax treaty being negotiated has been under negotiation since 2006. The negotiations broke down in 2008 and resumed earlier this year. There has been no meeting, no discussion and no rumor that the treaty was signed. I don't think investors are as idiotic to sell-off on this kind of event. Can we assign it to irrational behavior? I don't think so. If it was a precipitation of Greek crisis I could assign it to irrational behavior but not this. This is pure idiotic if traders have behaved the way did. I simply cannot believe people who pulled the trigger were looking at the treaty. The treaty negotiation news conveniently broke at the wrong time.

Second, some rudimentary analysis of treaty will tell you that Mauritius government is against taxation or sharing crucial information (though they have agreed to collaborate with Indian agencies on investigations). Further, most of Indian bureaucrats and politicians have routed money back through Mauritius. In effect, both sides of the negotiating table do not want capital gains tax or information sharing. So not much is going to be achieved on the treaty front. A rudimentary analysis will tell you this.

Third, look at the sharp fall with volumes. I guess a first trigger is through some algorithm at play rather than a thinking trader. The later drop down is more from margin calls being triggered than any fundamental issue. It is possible the algorithm may have estimated a fall to 5275 levels and adjusted to this very quickly triggering a panic in the process. It looks more like a work of computer than a human being.

In sum, I do not think a flesh and blood trader could have dumped that much volume in that short a time on that news. Alas, in the din of media drums the real explanations may be lost for ever. 

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