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Thursday, April 27, 2023

Author: Rishab Bailey

Rishab Bailey is a Lawyer, Technology Policy Researcher and Visiting Fellow, XKDR Forum, Mumbai.

On this blog:


We in XKDR Forum are recruiting in both policy & quantitative-research roles.

Quantitative research: we integrate multiple datasets (household survey data, firm data, macroeconomic and financial time-series, satellite imagery, legal systems data, other custom datasets) to obtain insights into the world aiming for academic research and real world applications. Along the way, we innovate on methods. Here are some examples: self reported health, informational efficiency of credit ratings, the working of financial markets, improved methods for nighttime lights radiance satellite imagery. We build open source packages in Julia and R, partly to do better computation around existing methods, and partly to express our innovations in statistical and computational methods.

The right persons for quantitative research at XKDR Forum are those who have knowledge of mathematics, statistics, computer science and economics, and take interest in the world, in applying quantitative tools to obtaining insights into the world. Existing capabilities with contributions to open source projects are a plus. Of great importance is collaboration with the policy oriented researchers in XKDR Forum.

Policy oriented research: we build knowledge on the working of government and how improvements can be made, and carry the knowledge through into connections into the real world reform process. We stand on the modern understanding of the Indian state and the difficulties of the Indian development journey, that fuses public economics, law and public administration, as seen in the ISOTR book. The X in XKDR Forum stands for Inter-disciplinary: we integrate diverse strands of knowledge into innovating on the question at hand. Of particular importance are the fields of government contracting, legal system reform, household finance, and climate change. Our thinking in each of these fields takes from and feeds into the big picture of Indian development strategy.

The right persons for policy research at XKDR Forum are those who take interest in the world, and bring social science and humanities insights into the world. Of great importance is collaboration with the quantitative researchers in XKDR Forum. 

In both categories, we care more about knowledge and passion, and less about the credentialism. High levels of intrinsic motivation are essential. Please look us up at: website, youtube channel, open source releases, annual conference, newsletter on substack.

The remuneration offered will be commensurate with your skill and experience and will be comparable with what is found in the Indian research ecosystem.

Interested candidates must email their resume with the subject line: Application for "Research Associate" at XKDR Forum, to Ms. Jyoti Manke at by 31st May, 2023.

Tuesday, April 25, 2023

Are startups engaging in innovation in India?

by Aneesha Chitgupi, Karthik Suresh and Diya Uday.


What is a startup? The academic literature takes a broad view --- startups:

  • have a high growth rate (Moogk 2012),
  • have a lower number of employees (Beck et al. 2008),
  • are at the early stage of the life cycle of a firm (Eisenmann 2013, Stevenson and Jarillo 1990), and
  • are drivers of innovation (Cohen and Klepper, 1996).

However, governments across the world focus on the link between startups and innovation. In the Netherlands, a startup is defined as "a business that translates an innovative idea into a scalable and generic product or service, using new technology." In the United States, a startup is one that "has never been an SEC reporting company, uses invested capital, often from venture capital investors, to build an innovative growth focused, scalable business." The Israeli "innovation model" is "largely based on the creation of technological value, mainly in start-up companies and multinational corporations R&D centres".

This is true of the Indian government as well. The stated objective of the Startup India Action Plan of 2016 is to promote innovation. The idea that startups are innovative is also reflected in the draft Science, Technology and Innovation Policy of 2020) as well as foreign policy initiatives like the Engagement Group on startups at the ongoing G-20 Summit.

The Startup India Policy offers a suite of regulatory exemptions and incentives linked to innovation by startups. Two key components of this policy are: (i) reduced fees and priority in processing patent and design applications for startups, and (ii) full exemptions on income tax to the startup following approval from an Inter-ministerial Board (IMB). The Startup India Policy has been amended several times. Key changes relating to the definition of a startup have been:

  1. February 2016: a startup is (i) not older than five years from the date of its incorporation/registration, (ii) turnover in any of the previous five financial years has not exceeded INR 250 million, and (iii) it is working towards innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property. The startup should develop and commercialise "a new or a significantly improved product or service or process that will create or add value for customers or workflow".
    To be registered with the DPIIT, as well as to qualify for the tax exemption, a startup needs to be recommended by a registered incubator, or an angel/private equity/ accelerator fund with at least 20 per cent funding, or by the Union or state government as part of a scheme to promote innovation, or it should have filed a patent.
  2. May 2017: the age of an eligible firm and the period for calculation of turnover was increased from five to seven years from the date of its incorporation/registration (ten for firms in the biotechnology sector).
    In addition to the definition, a startup may now also have scalable business models with a high potential of employment generation or wealth creation to gain benefits.
    To register as a startup and avail of the tax exemption from the IMB, a firm now only has to make an online application by providing the details of (i) certificate of incorporation/ registration and "other relevant details as may be sought", and (ii) a write-up about the nature of business highlighting how it meets the criteria in the definition. The DPIIT would consider "innovativeness" from a domestic standpoint. DPIIT may grant or reject recognition after review.
  3. February 2019: age requirement of an eligible startup was relaxed to ten years for firms across all sectors. The turnover limit was increased to INR 1 billion.

Given the emphasis on "innovation", we consider it important to examine whether India's policies are incentivising innovation by startups by asking the following questions:

  1. Are startups in India engaging in innovation?
  2. How innovative are Indian startups compared to non-startup firms?

To answer this, we require some well-accepted measure for studying startup innovation. We adopt the most popular method i.e. using patent fillings and grants as proxies to measure innovation (Wang 2018; de Rassenfosse 2019; Katila 2000). We chose this over other proxies like expenditure on R&D (Rothwell and Ziegler, 1981; Geroski, 1989). We examine our questions using patent filings and grants to startups. We also use a novel measure i.e. the benchmarks for innovation as defined under the Startup India policy. We found that startups are not driving "innovation" in the conventional sense of the term in India.

We lend new insights into the conventional wisdom on startups and innovation in India and highlight the need for a re-look at the current policy on startups in India.


We use two methods to determine whether startups are engaging in innovation:

(i) Measuring innovation using patent applications and grants: We hand-collected data on patent filings and grants from the Indian Patent Office across different categories of entities for the years 2016-17 to 2020-21. We substantiate this data using the annual reports of the Department of Promotion of Industry and Internal Trade (DPIIT). We examined the fraction of patents filed and granted by startups over the years compared to other entities.

(ii) Measuring innovation using startup registration and granted Income Tax (IT) exemptions under the Startup India Policy: The Startup India Policy 2015 requires startups to be innovative to (i) register as a startup and (ii) be granted IT exemptions under the Startup India Policy read with section 80-IAC of the Income Tax Act. We collected data on the number of startups that have successfully received tax benefits (after being classified as innovative). We then calculated the fraction of startups that were granted exemptions versus total startup registrations. For this, we collected data on startup registrations, applications for IT exemptions and approvals to applications of IT applications for all states and UTs in India between 2016-2022. We aim to gain insights into how many startups are "innovative" according to the policy definitions of "innovation".

We also collect currently available data on the total number of startups in India with the number of startups that are registered with the DPIIT. However, this is only available for the current year. We aim to examine how many startups in India qualify under the policy definition of a recognised startup to examine the stringency of the definition of a startup.

We conducted a detailed analysis of startup policies in India to give us further insight into our results from (i) and (ii) above.


Impressive growth rate in patent filings by startups but their overall share remains small: We examined patents filed and granted by Indian startups versus other Indian entities which include small firms, private and public firms, and natural persons. We did not include foreign firms and institutions filing for patents in India or Indian entities filing for patents abroad. We found, across the years, that the number of patents filed by startups has increased possibly on account of the fee waiver and fast-tracking of applications. We also see specific increases in the years in which these interventions were made (May 2017, February 2019) when patent filings doubled (see Figure 1). The CAGR for patents filed by startups and other entities show a disproportionate growth rate for startups at 54 per cent for the period between 2016-17 to 2020-21 which was nearly 12 per cent for other entities for the same period. We found that startups constitute a small proportion of the total patents filed in India when compared to other entities. Patent filings were largely driven by large firms and universities.

Figure 1: Fraction of patents filed by startups over non-startups (2016-17 to 2020-21)

Disproportionately fewer startups were granted patents: The share of patents granted to startups peaked at 8.8 per cent during 2017-18, remained the same the following year and has declined since then. One reason for this could be that startups were obliged to file for a patent to receive registration under DPIIT as well as for applying for IT exemption. The reason for the drop in shares of both patents filed and granted during 2020-21 could be the removal of patents as a condition for registration of a startup and for IT exemption (in May 2017). We also believe that there could be an overall decline in the quality of patents filed. It appears that while the current policy has incentivised firms to file patents, their applications do not pass the more stringent test of proving innovation and hence they fail. The threshold required to grant a patent is strict and requires a firm to prove novelty, which is not the case at the application stage where anyone may file for a patent.

Figure 2: Fraction of patents granted to startups over non-startups (2016-17 to 2020-21)

Source: Annual reports of Indian Patents Office

Figure 1 showed that the share of patents filed by startups in total patents filed was rising during the period 2016-17 to 2019-20. This is not the case for the share of patents granted (Figure 2).

Less than two-fifths of startups registered with DPIIT qualify for benefits: We find that since 2016, the number of companies registered as startups under the Startup India Policy with the DPIIT has increased in absolute terms. However, the growth rate over time has reduced. We further find that out of all the startups that exist in India, only a percentage of them qualify as "startups" under the Startup India Policy and have been registered as such. For instance, there are 2,49,107 startups in India (as on February 2023) out of which only 90,939 (36.5 per cent) are registered by the DPIIT as startups. It is possible that the unregistered startups have either not applied to be registered or have not qualified as startups as per the definitions. This raises the question: is our current definition of a startup under the Startup India Policy the right one? Should we rethink the definition to extend the benefits of the policy to more startups on the ground?

Low grant percentage of IT exemptions for startups: We found that out of the total number of registered startups, less than 2 per cent of startups have been granted the IT exemption, signifying that few startups have been certified as innovative as described in the Startup Policy on external scrutiny by the IMB. We validated this with data on the number of applications for the IT exemption for the year in which this data is available (2017) and found that 90 per cent of registered startups applied for the IT exemption in that year. This indicates that the low fraction of startups receiving IT exemptions is not for the lack of application on the part of registered startups. This has even prompted questions in Parliament.

To be registered as a startup under DPIIT, a startup has to only declare that they are working towards innovation, whereas to obtain an IT exemption, the fact of innovation is scrutinised by the IMB based on specific criteria because of which a startup may not qualify. It is possible that, at registration under the policy a startup need not demonstrate innovation but only declare it, however, for the IT exemption it must now demonstrate and prove innovation in the manner specified in the policy. It appears that few startups are actually being innovative according to the Startup India Policy. Table 1 summarises our findings.

Table 1: Total startups registered and granted IT exemptions based on whether they are "innovative" (2015-2016 to 2020-21).

Year Number of startups registered Growth rate (%) No of startups granted 80-IAC Fraction of total (%)
2015-16 471 -- 7 1.5
2016-17 5233 1011 69 1.3
2017-18 8775 68 18 0.2
2018-19 11417 30 162 1.4
2019-20 14596 28 83 0.6
2020-21 20160 38 70 0.3

Source: Authors' calculations from DPIIT data

Limitations: (i) We do not have access to consistent yearly data on the number of total startups v. those which are registered. (ii) We do not have data on the pre-policy period. (iii) Our present study is not focused on industry-level features. We intend to pursue this in the next leg of our study.


Our findings indicate that both measures --- IT exemption grants based on innovation and patents filings and grants --- suggest that innovation in India does not consistently emerge from startups. Instead, our findings are in line with studies in other jurisdictions which suggest that large firms undertake most innovation on account of their risk appetite and R&D capacity (Cohen and Klepper 1996, Symeonidis 1996). Our findings are also aligned with reports that indicate large firms and universities engage most in innovation if measured by patent filings in India. Is this, however, a true picture of innovation on-ground? And what are the implications of our findings for current innovation policies for startups?

The literature makes the case for government intervention on startup innovation citing the disparity in the ability to compete as a market failure (Wang 2018, Symeonidis 1996). The argument is that startups require a boost to even out the playing field as they are unable to compete with larger firms with more resources. Our findings lend some support to this by demonstrating that (i) startups in India are not innovating as much as large firms, and (ii) patent filings by startups have increased since the Startup India policy came into effect. We also, find that patent grants to startups have not increased. Therefore, despite government intervention in India, startups are not driving innovation. Some explanations for this are as follows:

  • The current set of incentives may not be sufficient to drive startups to innovate more. We find some support for this in the literature that finds that supply-side policies alone (e.g. subsidies) are not sufficient to stimulate innovation (Geroski 1989). Focusing on additional demand-side measures such as public procurement of innovation from startups may trigger greater innovation as it reduces the market risk for innovators (Rothwell et al. 1981; Tiwari 2017).
  • Conventional notions of innovation are linked to "novelty" through patenting which is a very high standard for measuring innovation. In reality, startups in India may be engaging in innovation which is not eligible for conventional patents such as technological improvements or modifications suited to the domestic context. Reports suggest that startups in India adopt rather than innovate in the conventional sense. For instance, India is using the technology adoption route for developing Web3.
    Another reason could be that Indian firms are innovating but are not registering patents in India. Reasons for this range from poor enforcement in India to sector-specific commercial preferences. An example of the latter is the semiconductor sector --- India has a large chip design industry but this work is done on a contract basis for US semiconductor firms which file their patents in the US.
    Therefore, patents may not be the best way to measure innovation in India. Current startup policies in India should re-think the definition of "innovation" and make it more suited for the Indian context.

We gain some insights from the innovation-linked incentives that are offered by other countries. In South Korea, which has the highest per-capita granting of patents in the world, all startups irrespective of how innovative they are qualify for reduced fees in patent filings and certain tax exemptions available to SMEs. South Korean policy appears to focus more on promoting linkage between large and small firms to promote networking and market access. In the Netherlands, which ranks ninth in the world in patent filings, vouchers are given to SMEs for patent filing that cover up to 75% of costs. The Dutch Tax Office evaluates and grants specific tax incentives for "technical-scientific research" and "development projects". Both these countries, considered to be highly innovative, have tax schemes that are targeted at specific outcomes and there are some general exemptions for patent filings. India could perhaps learn from these policies.


We set out to answer two questions in this article: Are startups engaging in innovation? How innovative are startups compared to non-startup firms? Our findings using both measures indicate that startups are not driving "innovation" in the conventional sense of the term in India. However, many Indian startups have scaled up by engaging technology towards creative solutions in many industries such as payments (Paytm), e-commerce (Meesho), credit cards (CRED) and healthcare delivery (PharmEasy). While these firms may not do well on the conventional measures of "innovation", they have played a role in encouraging entrepreneurship to solve everyday challenges, all while benefiting their shareholders.[1] Policy in India must, therefore, be suitably modified to recognise such contributions towards innovation. This is an emerging idea that Indian policymakers are increasingly acknowledging. For instance, the Economic Advisory Council to the Prime Minister of India noted the importance of FDI from tech transfers as a key source of promoting innovation in India. We need to think harder about what "innovation" means in India and what role should the government play in encouraging innovation.

In further research, we will analyse the pattern of patents filed and granted across various industries to understand which sectors are more innovative in the traditional sense. We will also examine the firms that have received the IMB's certification of being "innovative" to (i) study the characteristics of these firms and the industries to which they belong, and (ii) study the trends in the grant of certification by the IMB for innovation to startups. This will help us gain a more nuanced understanding of what drives innovation among startup firms in India.


[1] According to its Red Herring Prospectus filed at the time of its IPO (November 2021), Paytm does not own any patents.


  1. Tom Eisenmann, Entrepreneurship: A Working Definition. Harvard Business Review, January 10, 2013.
  2. Stevenson, H. H., and Jarillo, J. C., A Paradigm of Entrepreneurship: Entrepreneurial Management. Strategic Management Journal, 11 (1990), 17-27.
  3. Dobrila Rancic Moogk, Minimum Viable Product and the Importance of Experimentation in Technology Startups, Technology Innovation Management Review, March 2012.
  4. Beck, Thorsten and Demirguc-Kunt, Asli and Maksimovic, Vojislav, Financing patterns around the world: Are small firms different?, Journal of Financial Economics, Volume 89, Issue 3, September 2008, Pages 467-487.
  5. Jue Wang. Innovation and government intervention: A comparison of Singapore and Hong Kong. In: Research Policy 47.2 (Mar. 2018), 399-412.
  6. Wesley M Cohen and Steven Klepper, A Reprise of Size and R&D. In: Economic Journal (1996), 106 (437), pp. 925-51.
  7. Gaetan de Rassenfosse, Adam Jaffe, and Emilio Raiteri. The procurement of innovation by the U.S. government. In: PLOS ONE 14 (Aug. 2019), pp. 1-11.
  8. Katila, R. Measuring innovation performance. In: International Journal of Business Performance Measurement (2000), 2: 180-193.
  9. P. A. Geroski. Entry, Innovation and Productivity Growth. In: The Review of Economics and Statistics 71.4 (1989), 572-578.
  10. R Rothwell and W Zegweld. Industrial Innovation and Public Policy: Preparing for the 1980s and the 1990s. In: London: Francis Pinter Publications (1981).
  11. G. Symeonidis, Innovation, Firm Size and Market Structure: Schumpeterian Hypotheses and Some New Themes, OECD Economics Department Working Papers, 161 (1996).
  12. S.A. Low and M.A. Isserman. Where Are the Innovative Entrepreneurs? Identifying Innovative Industries and Measuring Innovative Entrepreneurship. In: International Regional Science Review 38.2 (2015), 171-201.

Aneesha Chitgupi, Karthik Suresh and Diya Uday are researchers at XKDR Forum. We thank Devendra Damle, Josh Felman, Dr. R. A. Mashelkar, Amey Mashelkar, Megha Patnaik, Arjun Rajagopal, Anjali Sharma and the anonymous referees for their feedback and comments.

Tuesday, April 18, 2023

The place of short selling in the financial markets

by K. P. Krishnan, Renuka Sane, Ajay Shah, Anjali Sharma, Harsh Vardhan, Bhargavi Zaveri-Shah.

The Hindenburg report has reopened the Indian debate on regulatory restrictions on short selling. Is there market failure with activist short selling, that is, the practice of short sellers disseminating information (usually adverse) about the firms whose stocks they have shorted? Activist short sellers have the incentive to release negative information, which may be misleading or even false, aiming for maximal visibility. Does responding to adverse information impose an unreasonable burden of time and effort upon managers of the firm, and consequently higher costs on their customers? Is there a role for financial regulation to proscribe activist short selling or all short selling?

We argue that short seller activism improves market quality. The focus of financial regulation should be upon market abuse, and this includes market-based abuse and information-based abuse. In India, much of the policy discussion on short-selling is moot, given that short-selling, as is widely understood in the financial industry, is largely infeasible. In any case, in this globalised world, there is nothing that an Indian regulator can do about these activities taking place overseas.

Defining short selling

When a person has a negative view about the outlook for a financial price, she wants to sell. What happens when she does not own these shares? Short selling refers to the procedures on the market through which a person with a negative view can achieve a profit from successfully forecasting a price decline, even without directly owning the shares. There are roughly three ways to do this:

  1. Sell stock futures.
  2. Buy put options (or to sell call options).
  3. Borrow shares and sell them.

The #3 is termed “short selling”. This involves (a) Borrowing shares (b) Selling them (c) Waiting (d) Buying back the shares from the market (at a hoped-for lower price) and (e) Returning the shares with interest.

In India, for all practical purposes, short selling is infeasible. While the institutional mechanisms for borrowing shares exist on websites of exchanges (such as the `Securities Lending and Borrowing Mechanism’ (SLBM) which was first operationalised in 2008), the liquidity available is negligible.

Methods #1 and #2 are constrained by a variety of regulatory restrictions, such as small position limits and high margin requirements. As an example, the position limit on the stock futures for Infosys (which has a market capitalisation of Rs.5.86 trillion) is Rs.30.8 million. This is 0.000526% of its market capitalisation. If a person successfully predicts a 50% stock price decline in Infosys, but is only permitted to have a position of Rs.30.8 million, the profit from a correct prediction is just Rs.15.4 million. This maximal profit (under extreme assumptions) is not large enough for professionals such as Hindenburg. One can only do such India-linked financial activities outside India.

The symmetry between longs and shorts

Everything that has been said above about short selling is true in reverse. When a person has a positive view about the outlook for a financial price, she wants to buy. Here too, the person can choose to act on her information in three ways: (1) Buy stock futures, (2) Buy call/Sell put options, and (3) Borrow money and buy shares.

The freedom to transact in the securities markets is analogous to the freedom to speak. A healthy arrangement is one where both positive and negative views are expressed. The market price is the outcome of both kinds of persons transacting with each other, and financial policy should be neutral between these two kinds. One has a long position, who may speak in the public domain about the stock being undervalued and likely doing well in the future. The other has a short position, who may speak in the public domain claiming that a stock is overvalued.

At present, in India, there is full symmetry between longs and shorts when it comes to expressing views through the futures and options (in that both optimists and pessimists have limited possibilities to put their money where their mouth is). On the #3 path, however, it is easier to borrow money when compared with borrowing shares.

A marketplace of ideas

The securities market is a classic example of a ‘marketplace of ideas’. There are many lines of reasoning which lead to diverse predictions about whether prices will go up or down. Each trader chooses an information set and an analytical strategy which makes sense to her. As Milton Friedman emphasised, there is a Darwinian process where those who forecast poorly lose their capital and end up having a lower influence on prices, and vice versa.

Sometimes, the phrase “market efficiency” is overstated to expect perfect forecasts. It is more useful to think of the market as a human construct, as an aggregation mechanism where multiple individuals, each with different sets of incomplete information, try to forecast better than each other. If this process is to deliver efficiency, it requires an environment of freedom: freedom to enter the market, to obtain and process information, to express views through trades, and through speech.

Current regulatory approach

The present Indian thinking on the role of having skin-in-the-game is confusing. On some occasions, the Indian state has held the lack of skin-in-the-game against market participants. In fact, if the person had no skin in the game, then she could say anything, and face no consequences. When she can lose money if she is wrong, the quality of the forecasts backing the speech is likely to be higher.

The Indian debate on government control upon short selling also needs to recognise that in the globalised world, the constraints on this activity in India have helped push it overseas, beyond the reach of Indian regulators.

Benefits for society from short selling

The resource allocation of the market economy is controlled by financial prices. As the old saying goes “finance is the brain of the economy”. When this brain works better, the scarce resources of the society get put into better use, thus improving the translation of savings/investment into growth.

Prices constantly fluctuate, frequently becoming a bit too high or a bit too low. The job of continuously correcting them is done by traders, who constantly look at these prices, and who form a judgement about whether a certain price is too high or too low. The people with forecasts are often not the people with the securities or money. It is efficient for society to create mechanisms through which people with forecasts are able to take buy or sell positions, thus feeding their information into prices. These activities continuously push prices towards fair value. It is best for these activities to be symmetric: buying and selling are both equally legitimate as both over-priced and under-priced securities are equally a problem.

Consider a share with a fair value of Rs.100. When mispricing takes place in the lower direction, i.e. the market is underpricing the share, the price can go as low as Rs.0. On the other side, however, the mispricing can go up without constraints. There is no arithmetic limit on how high prices can go, to Rs.1,000 or Rs.10,000 or beyond. Some entrepreneurs have pursued get-rich-quick schemes, where over-pricing of share leads to benefits such as achieving power in a society that glorifies financial success, obtaining enlarged loans against overvalued shares as collateral, and raising capital through primary issuance at elevated securities prices.

In advanced economies, the gains from short sellers are well established in the research literature and in policy thinking. Short sellers played a key role in calling out Enron’s accounting fraud, the Wirecard fraud and several other such situations with falsified financial statements. Researchers have found that short selling activity helps uncover firms that misreport financials faster. There is a well-known bias in favour of buy recommendations by stock analysts. Short sellers have often countered these over-optimistic valuations and often won the debate. Investigative reports by short sellers have often acted as cues for enforcement authorities to commence investigations into potential wrongdoing. For example, after Hindenburg’s 2020 report into the E.V. Maker Nikola, the SEC began an investigation into the company that led to conviction of the CEO of Nikola for fraud.

Every society suffers from problems of fake it until you make it. In the Indian institutional environment, there is certain appeal of schemes which generate meteoric financial success, which can help create financial and political capital for use in intimidation and fending off future investigations. Short selling is, then, particularly valuable in India given the limitations of state capacity in financial market regulation: the optimal space for short selling in India should be greater than that seen in advanced economies.

How does this connect up into financial markets regulation?

In the standard toolkit of financial markets regulation, e.g. as is done by the Financial Sector Legislative Reforms Commission (FSLRC), there are three classes of interventions by the state that address market failure:

  • Market-based abuse: The use of market power on the market to force the price away from fundamentals.
  • Information-based abuse: Falsification of the information set of the market so as to force the price away from fundamentals.
  • Insider trading regulation: The use of insider information for profitable trades by insiders (which bring the price closer to fundamentals).

Regulators should enforce against all these three problems, regardless of whether short selling (or long buying) is in the picture. However, if it is felt that short selling (or long buying) always involves one or more of these three classes of problems, this is incorrect. There are many short selling (and long buying) transactions in this world which are free of these three problems.

In India, the `Prohibition of Fraudulent and Unfair Trading Practices’ (PFUTP) Regulations are designed to deal with market abuse of both kinds (market-based abuse and information-based abuse). PFUTP regulations have been one of the most frequently enforced regulations in the Indian securities market with a reasonably high conviction rate (Damle and Zaveri-Shah, 2022). SEBI may issue directions to pre-empt such conduct and impose sanctions in the form of monetary penalties, with the directions often having a punitive effect as well.

Finally, under present Indian law, defamation, including corporate defamation, is a civil and a criminal wrong. For instance, recently, Edelweiss sued Moody’s for defamation for misrepresenting the former’s financials, demanding exemplary damages. An analyst went to jail for writing about Indiabulls. A firm could choose to act against an activist short seller through these tools also. In these threats also, the Indian setting is different from that in advanced economies.

We enumerate these features of the Indian legal system to shine a light on the existing methods through which state power can be brought down upon behaviours adjacent to the short selling debate, and not to endorse them. The present frameworks need much improvement. The PFUTP regulations have imprecise drafting and leave ample scope for discretion. The economic logic of harsh penalties against insider trading is questionable, as insider trading takes the market price closer to fair value. The Indian limitations on freedom of speech -- all the way to the 1st amendment -- need to give way to the blossoming of enlightenment values. For the present discussion, however, we wish to point out that when we think of bad behaviour that might go alongside short selling (or long buying), there is an institutional apparatus (that needs much improvement) which addresses these. There is nothing special about short selling (or long buying) that calls for new work by way of state coercion.

What should managers do in the information space?

Finally, we turn to the burden upon managers to respond to rumours / allegations in the information space. Firms release a set of regulated disclosures into the public domain, and are held accountable for the veracity of these claims. It is the responsibility of the managers of listed companies to operate the information process through which these facts are created and disseminated. Firms with listed securities are coerced by the state to release a certain set of correct facts about the firm, into the public domain, to enable and assist the process of speculative price discovery that creates the public goods of an efficient price and market liquidity. Such firms are also coerced on not speaking publicly, in ways which release information, outside of the regulated processes for information release.

There is, however, no role for state coercion in favour of public release of facts about market participants. As there is no market failure, they should be free to trade and speak as they please, other than the rules about disclosure of insider trades.

The information space that shapes the stock price is populated with numerous elements outside the firm:

  1. The full information space is vastly greater than the set of mandatory disclosures. There is an important information space of unregulated facts. Third parties can and do construct facts about the firm with no involvement of the firm, and outside of the regulated facts overseen by SEBI. For example, a private person can obtain private satellite imagery and count the number of cars parked at DMart locations, and thus estimate revenues of DMart. It should be the privilege of such a person to compute and/or release such estimates, and be fully free on using precise or imprecise methods in the computation.
  2. Third parties knowingly or unknowingly do create false facts about the firm. This is a normal and healthy part of the information space. Freedom of speech contains the freedom to utter sentences that are wrong. Obtaining precise facts is difficult and should not be crushed under state coercion where persons are punished for uncovering or speaking false facts.
  3. Third parties can apply diverse analytical techniques based on which forecasts are made about the operating performance or future stock price movements of the firm. These forecasts are subjective and (in a healthy society) will diverge greatly. All these are inputs for speculators who then come together into the process of price discovery on the financial markets.
  4. In this rich landscape, the state cannot be the arbiter of what is true vs. what is false. The state does not have such institutional capacity -- this is the work of market participants -- and it would constitute censorship.

What should managers of firms do about this information space? Most firms voluntarily choose to have an investor relations capability, through which they are able to engage with some institutional investors and communicate the state of the firm to them. These conversations are, of course, limited by concerns about leaking non-public information to some investors and thereby giving them an edge.

Should managers do anything else, over and beyond these traditional investor-relations activities? Should managers monitor blogs and social media, and scotch false rumours about the firm? Once there is ample trading by diverse kinds of persons on the financial market, there will be reasonable levels of market efficiency. The astrologers and technical traders and econometricians will sort out their differences -- on the market. Liquid and efficient markets are quite able to absorb all manner of influences. The difficulties of information space reiterate the prime objective of financial economic policy as creating conditions for market liquidity - by having a stock lending mechanism that works, by not having tiny position limits, by freeing up capital controls, by not reducing exchanges into arms of the state, etc.

It is not the job of a cricket team to influence the speech or bets of spectators. We think that managers competing in the information space is a bad use of managerial time and energy. If we were members of the board of a company, we would generally favour the application of the resources of the firm towards strengthening the operations and the outputs of the firm. SEBI recently proposed amending its Listing Obligations and Disclosure Regulations to require large listed companies to confirm, deny or clarify false rumors in the market. We do not see the market failure that can motivate such state coercion: this should be the prerogative of the board and not forced by the government.


Damle, D., & Zaveri, B. (2022). Enforcement of Securities Laws in India: An Empirical Overview. Social Science Research Network.

Tuesday, April 04, 2023

Revising the Information Technology Act, 2000

by Rishab Bailey, Vrinda Bhandari, Renuka Sane and Karthik Suresh.

The Information Technology Act, 2000 ('IT Act') is a comprehensive law enacted to build trust in the digital ecosystem by regulating e-commerce, e-filing of documents, and by creating criminal offences applicable to the digital ecosystem. Despite amendments in 2009, it is widely considered that the IT Act is outdated, not least due to the proliferation of the Internet and a range of new technologies (e.g. Bahl, Rahman and Bailey 2020; Nappinai 2017; Nigam et al 2020). Recently, the government has proposed replacing the IT Act with a new legislation known as the 'Digital India Act'.

In a new report, Revisiting the Information Technology Act, 2000, we attempt to contribute to the process of revision of the IT Act, by examining four critical issues pertaining to the online ecosystem. These are:

  1. Censorship: The provisions in the IT Act pertaining to censorship and blocking were framed in an era when the digital ecosystem was not as pervasive as today and before the use of social media platforms exploded. The provisions in the IT Act that empower the government to block content from public access are largely based on Article 19(2) of the Constitution. However, the institutional framework for carrying out blocking suffers from significant lacunae, including a lack of accountability of the relevant oversight institutions. We recommend that appropriate procedural safeguards be introduced through statute, to ensure greater transparency and neutrality in the blocking processes.
  2. Intermediary liability: The IT Act protects intermediaries from prosecution for content posted or transmitted by third parties upon the following three conditions: (a) that they act as passive agents (or distributors) of content, (b) they disable access to unlawful content upon receiving 'actual knowledge' thereof, and (c) they observe 'due diligence' conditions laid down by the government. The 'safe harbour'' provision was introduced at a time when the digital ecosystem was still nascent. The variety of online harms that have since proliferated raise questions about whether such a system is required. We find that there is value in retaining a safe harbour for intermediaries in contexts where they have played a passive role in the ecosystem. Removing safe harbour is likely to incentivise greater private censorship, a role that intermediaries are not well positioned to undertake. However, this does not mean that intermediaries should not be responsible for ensuring the safety of the digital ecosystem. Any further obligations (such as greater transparency, the introduction of grievance redress mechanisms, etc.) ought to be implemented outside the safe harbour framework and certainly not as part of amorphous 'due diligence' obligations. We point to how new intermediary rules introduced in 2021 and 2022 have imposed a variety of new and onerous obligations on intermediaries. Many of these obligations, such as the obligation to enable traceability of the originator of information on messaging platforms and the obligation or the need to practically police a host of proscribed content, should be done away with. Any new obligations must be introduced based on evidence of harm in a proportionate manner.
  3. Surveillance: The current framework pertaining to interception and monitoring of digital communications was established before the seminal decision of the Supreme Court in Justice K Puttaswamy vs. Union of India which recognized privacy as a fundamental right. Our report builds on the literature on surveillance reform in India to suggest that significant revision is required in our legal framework. Currently, the executive is provided extremely broad powers with insufficient safeguards to mitigate abuse. Certain surveillance programs such as the Centralised Monitoring System are per se disproportionate as they conduct mass surveillance. Our primary recommendation is therefore to enact a new stand-alone surveillance-related legislation, which could harmonise surveillance processes while ensuring that appropriate procedural and institutional safeguards are implemented. In the alternative, the revised IT Act should narrow the scope of powers given to the executive, while also implementing workable oversight and accountability mechanisms, not least ensuring judicial review, legislative oversight, and greater accountability of relevant bodies involved in the surveillance apparatus.
  4. Cybersecurity: While the IT Act lays down various offences pertaining to cybersecurity that are broadly in accordance with international standards, we find that there is a significant need for reform of the institutional mechanisms that manage incident reporting and response. We recommend that the revised IT Act clarify the role and powers of CERT-in and NCIIPC --- the two primar cybersecurity-related agencies in India. In particular, their rule-making powers should be clarified/limited. The law should also avoid duplicating functions of each agency while limiting incident reporting requirements to large and systemically important systems and entities --- this avoids imposing disproportionate costs.

As we move towards an economy that is ever more dependent on the digital ecosystem, it is vital that the law promotes trust in the online ecosystem. This involves finding an appropriate balance between a range of competing interests --- national security and public order, the need to protect fundamental rights, and the need to promote innovation in and development of the digital ecosystem. Finding such a balance will require the government to take a considered stance on several thorny issues. Carrying out detailed and inclusive consultations will also be a vital part of the process towards establishing the digital ecosystem on a sound legal footing.


Varun Sen Bahl, Faiza Rahman and Rishab Bailey, Internet intermediaries and online harms: Regulatory Responses in India, Data Governance Network Working Paper no. 6, March 2020.

N S Napinnai, Cyber security and challenges: Why India needs to change IT Act, February 2017.

Aniruddh Nigam, Kadambari Agarwal, Trishi Jindal, Jaai Vipra, Primer for an Information Technology Framework Law, Vidhi Center for Legal Policy, September 2020.

Rishab Bailey, Vrinda Bhandari, Renuka Sane, Karthik Suresh, Revisiting the Information Technology Act, 2000, XKDR Forum, March 2023.

Rishab Bailey and Karthik Suresh are researchers at XKDR Forum. Vrinda Bhandari is a practising advocate. Renuka Sane is a researcher at TrustBridge.