CB Bhave, Chairman of the Securities and Exchange Board of India (Sebi) in his adress and conversation with CNBC-TV18's Managing Editor, Udayan Mukherjee, at the Hindustan Times Leadership Summit, said that India is closely linked to the world economy and the global credit markets, especially via trade but feels India would be amongst the fastest in the world to recover.

"Every crisis is an opportunity. We have learnt a lot during the month of October. We should use this opportunity to improve our system. When the chips are down, we must build for the future, and not just be unhappy that the chips are down, because this country will recover most probably amongst the fastest in the world. We will feel the effect of what is going on in the world but we will be amongst the first few that recover. When we do recover, our weight in the world will be more than what it was before the crisis."

Bhave is uncertain as to when the markets will bottom out and he advises people not to put all their savings and emergency funds into equity. He said that investors need to diversify asset allocations in order to reduce their losses and advises investors against timing the market.

The Chairman said he has not seen any manipulation in the market so far.

Bhave rues that evidence indicates that leveraged FIIs are getting out of the Indian market and that institutional investors with leveraged clients too are leaving the market. However, he said long-term investors like pension funds were still investing in India.

Let me begin with the problems that the world is facing today. In August 2007, the United States (US) and the European markets had discovered that their financial institutions were carrying on their books assets which came to be known as sub-prime assets of which they had no idea of how to value.

The whole thing came up when one of the banks in its quarterly report said, “I do not know how to value my book.”

That created a fear in investor’s minds that all these balance sheets and profit and loss accounts may just be a story and which required more reading into. They feared these numbers did not reflect the actual state of affairs.

After August 2007, till January 2008 Indian market kept booming. So a theory developed around that time that we were decoupled from the Western economies and India was relatively in isolation and would charter its own cost.

Our focus of attention was essentially on the stock markets. Then the market had some shocks in January then saw some recovery and in subsequent months saw a fall again and so on. Till September 15, when one of the biggest US financial institution, Lehman Brothers was allowed to go bankrupt, we had not realized how closely linked with the world we were.

Even on September 15 indian did not realize the profound effect it would have on the economy. Interestingly even the Western regulators did not see this recession.

This effect was not on the stock markets, the effect was on the credit markets.

One of the things we probably missed out is the importance of credit markets in the world.

As Lehman went down – there was already this fear for a period of one year in the minds of investors of whether balance sheets portrayed a true picture of the bank properly or not. Then, another peculiar thing happened i.e. institutions stopped trusting each other.

So if a bank doesn’t trust another bank then credit markets cannot function and if credit markets don’t function then trade and commerce is impossible.

It took us about 15-20 days to realize how closely interlinked with the world we were through the credit markets because our trade credit got affected, some of the companies were raising even their working capital requirements on the international markets. We started having the phenomena of these companies wanting to raise the same money in the Indian markets and we had a huge liquidity squeeze and two shocks in October when we went through a liquidity squeeze.

This resulted in an impact on the mutual fund industry because all corporates then wanted to withdraw from the liquid schemes of mutual funds.

The mutual funds in turn found that their underlying assets had no markets because nobody had money, so nobody was going to buy these assets. So we had to take some emergency action. The basic point I want to make here is that we are very closely interlinked with the world even though we are not a capital account convertible country and therefore the capital linkage is not so much but the linkage through trade is tremendous.

Since short-term capital got affected in this manner and credit market seized, the question for us to ask is why did something similar not happened in the equity markets? Why did people not lose faith in each other and why did they not stop transacting? The answer takes us back to the question that probably equity markets are organized far better.

These are exchange traded markets and these markets have what all called clearing entities. These clearing entities take the counterparty risks.

Therefore when a broker puts a trade on a stock exchange, he does not worry as to who the counterparty broker is. He knows that at the end of that day, the clearing corporation is my counterparty and that clearing corporation holds enough money by way of margins and a guarantee fund to be able to complete that transaction. 

It is through building this infrastructure, these clearing corporations didn’t exist in our markets ten years ago, it is in the last ten years that this country has acidulously built these clearing corporations, the regulator has required and the market has responded by adequately creating big enough settlement guarantee funds and the ability to give this counterparty guarantee a margin mechanism which hasn’t failed despite the fact that more than 50% of the index is off.

The point I want to make with reference to this crisis is that this is an opportunity for us to study what went wrong not because we want to pin the blame on X, Y or Z or be happy that some developed markets made mistakes and we are great. But to study this phenomenon in order to learn as to what do we need to do when we become as big as them. Do we have the institutional capacity to handle these things and if we don’t what efforts do we need to make?

The bank said ‘I do not know how to value the assets in my book’. So when there are over-the-counter trades as opposed to exchange trades, prices are not transparent and when prices are not transparent, it is not possible to create a clearing agency which will clear this trades with the guarantee that irrespective of who your counterparty is I will put this trade through.

So to my mind our effort as regulators, as systems, as market player should be to see that we take as many financial products as possible on to an exchange traded market.

One of the small beginnings that we have made in this direction is to bring currency futures on to the exchange traded platform.