The Securities and Exchange Board of India has rightly been saying there is no need to ban short-selling. It is as a matter of prudence that it has said its options are open. So, it is imprudent to assume now that Sebi is actually exploring the option — but, if it is, the plan should be nipped in the bud.

Illustration: Jayachandran / Miint

Some politicians and brokers are demanding such a ban to curb the sharp fall in equity prices. At least some of them don’t realize there are hardly any short-sellers in the Indian cash market for equities. One can only sell stock one owns and for those who don’t own shares, the option is to borrow them from the securities lending market and then short them. The securities lending market is now defunct in India — with no trades, there is no opportunity for short-sellers here. Foreign institutional brokers, however, do lend shares held on behalf of investors (who are issued participatory notes) to some short-sellers overseas. Sebi has now diaspproved of this practice, but recent data it has published on such lending indicates that is not much relative to the size of the market.

Most of the short-selling in India takes place in the single-stock futures and options market. A short-seller could either sell futures, buy put options or sell call options to take naked short positions in Indian securities. A short sales ban means shutting down the entire single-stock derivatives market. In developed countries, the ban has meant shutting access to one section of the market — naked short-sellers who do not borrow shares before selling them short. The market still functioned as all forms of buyers and sellers with underlying stock could still trade. The single-stock options market, too, continues to function.

That’s very different from shutting down an entire market. In India, for a number of securities, liquidity in derivatives trading is higher than the cash market. Closing this market in an ad hoc manner would hit investor confidence. Those with open positions will be the worst hit as they would be forced to square off at a pre-determined price. When and if the market resumes trading, volumes would be much lower, thanks to fears of further ad hoc regulation.

In any case, the ineffectiveness of banning short sales is evident in the US experience. Washington Mutual and Wachovia failed after the ban on short sales on 19 September. Shares of financial firms have continued to slide since then.

True, there is a case for curbing manipulation, even by those who take short positions and then spread false rumours about a firm. The answer is not to ban all short-sellers, but to go after the manipulators.

Will blocking single-stock derivatives help Indian markets? Write to us at views@livemint.com