Volumes are likely to shrink sharply in the coming weeks

Market analyst Rajesh Jain

The regulator, the Securities and Exchange Board of India (Sebi), has also decided to introduce options in a group of selected scrips to bring the Indian markets in line with the more developed capital markets of the West.

To give some breathing space to speculators with positions invested through the carry forward mechanism, Sebi has allowed them until 3 September to wind up holdings.

But all carry forward positions from 15 May onwards will have to be squared off by 2 July.

Bigger trading volumes

The carry forward regime has long played a big role in India's investment culture, and has allowed traders to carry forward their trades from one weekly settlement to another by paying a margin of about 20%-25%.

Calcutta's stock exchange suffered badly

This system, unique to the Indian markets and in practise for nearly 100 years, in effect allowed investors to trade on credit - to increase their exposure to the market without paying cash up front.

This contributed to increased trading volumes, but also exposed the markets to sharp bouts of volatility.

Many market players also blamed the carry forward system for the excessive speculation witnessed in the Indian markets in the last couple of years.

Excessive speculation

The system was also implicated in a payment crisis which hit the Calcutta stock exchange in March, when a sharp fall in stock prices left a group of brokers with big carry forward positions unable to honour their financial commitments.

But despite the drawbacks of the system, the carry forward system was viewed as a lifeline for domestic stock markets.

Rajesh Jain, stock analyst with Bombay brokerage firm Pranav Securities, said the Indian markets will suffer.

"Volumes are likely to shrink sharply in the coming weeks and the markets may drift lower in the absence of speculative play," he said.

Carry forward trades accounted for nearly 90% of trading volumes in the Indian markets and the fears of market players about volumes getting restricted appear justified to many.

But Sebi chairman, DR Mehta, told the BBC that he was confident the markets would respond well to a measure which will not only curb excessive speculation, but do away with a system which was sometimes used by unscrupulous operators to rig the stock markets.