Front-Running in the Stock Market

The practice of front-running has come into focus.

What is Front-Running?

Front-running is an illegal activity involving the purchase of stocks based on unpublished information about large transactions that could influence stock prices. This allows those with insider information to gain profits by acting on the information before the market reacts.

How Does Front-Running Work?

• Institutional investors like foreign funds, mutual funds, and hedge funds initiate large trades.
• Insiders and brokers are privy to these trades' size and execution price.
  • For example, a broker aware of a client's order to buy many shares may purchase shares before executing the order.
• Once the client's trade is executed, the insider sells the shares at a higher price for profit.

Why is Front-Running Illegal?

• Creates an unfair advantage and manipulates market prices.
• Undermines trust in financial markets.
• Violates fiduciary duty, where brokers or advisors must prioritize the client's interest.

Difference Between Front-Running and Insider Trading

• Front-running involves breaching fiduciary duty by profiting off client information.
• Insider trading involves using non-public insider information by executives or employees.
• Both are prohibited by Sebi, but insider trading does not require a fiduciary breach.

Analysis of India's Forex Reserves Policy

The unexpected nature of global political and economic developments, as highlighted in Oscar Wilde’s play, is a fitting backdrop for discussing India’s approach to foreign exchange reserves in the wake of Donald Trump's presidency and potential protectionist policies.

Potential Trade War and Economic Impact

• Higher tariffs: Expected to disrupt multilateral trade, affecting not only China but also allies like Canada, Mexico, and BRICS members.
• US Dollar Strengthening: Likely to impact India's trade deficit and inflows, as investors may seek safer havens.

Role of Forex Reserves

• Purpose: Primarily to finance the Current Account Deficit (CAD), which is the excess of imports over exports.
• Additional Benefits:
  • Provide insurance against sudden shocks or reversal in inflows.
  • Reduce BoP crises likelihood and preserve economic stability.

Challenges with Holding Large Reserves

• Opportunity Cost: Reserves must be invested in low-yield avenues like US Treasury bills, yielding less than Indian securities.
• Limited Assurance: Large reserves do not guarantee resilience, as evidenced by the dollar's weaponization post-Russia-Ukraine war.

Current Reserve Policy Debate

• Import Cover Strategy: Traditional approach focused on maintaining three months of import cover.
• Exchange Rate Volatility: Post-reform, focus shifted to smoothening exchange rate fluctuations.
• Intervention Effects: Despite interventions, the rupee's depreciation suggests a need to reassess reserve use.

Policy Alternatives

• Reserves Composition: Consider holding more gold and less US dollars.
• Rupee Depreciation: Evaluate the benefit of allowing the rupee to reflect its Real Effective Exchange Rate (REER) instead of using reserves to support it.

In conclusion, the notion of being prepared for unexpected global shifts calls for a thorough review of India's forex reserves policy to ensure it aligns with contemporary economic challenges.