‘Short sellers are market’s janitors’: Zerodha’s Nithin Kamath warns of price distortions in Indian equities due to lack of short-selling

India’s equity markets are at risk over growing inefficiencies which are due to limitations placed on the practice of short selling, Zerodha co-founder Nithin Kamath has warned. In a social media post, Kamath has called for urgent reforms to improve price discovery and market integrity.

“The lack of short selling in Indian markets is causing potential market distortions. Unless we make shorting of stocks easy in the Indian markets, price discovery will be impaired,” Kamath said.

In a detailed post, Kamath flagged what he calls the long-standing bias present within Indian equity markets towards taking a long-only investing position and called it a 'key concern,' noting that the current infrastructure makes it difficult for investors to borrow and sell stocks they don’t own.

“India has been a structurally long-only market with almost no shorting activity, because borrowing stock to short is really hard and is an offline process,” he said further.

India’s equities ecosystem has largely discouraged short selling due to procedural hurdles, with Securities Lending and Borrowing (SLB) still being an offline and broker-dependent process. As a result, there’s little participation or talent pool in short strategies, Kamath added.

In fact, Kamath suggested that the long-only investing thesis has resulted in drying up of talent needed to short sell stocks in India, even if fund houses are keen on it.

“Because of this long-only bias, there's probably very little short-selling talent as well, even if large funds want to start shorting. The only real way to short stocks until now was to use futures, maybe options. But there are only 224 F&O stocks, which means you can't short the vast majority of the problematic stocks. Also, these contracts expire every month, and the cost of rolling over these contracts is significant (only the 1st month contract is liquid),” Kamath wrote.

Kamath further likened short sellers to “janitors” of the financial markets. “They clean up all the garbage and make markets more efficient,” he said. Despite their often-controversial reputation, short sellers play a critical role in curbing excesses and exposing weak fundamentals, he argued.

Zerodha, India’s largest retail brokerage, currently supports SLB transactions, but Kamath admitted the process remains cumbersome. “You’ll have to call us to borrow or lend, and there’s a process, which means it’ll never scale,” he said, adding that Zerodha aims to launch an online platform for SLB by the end of the year.

With the Indian stock market reaching new highs and retail interest at record levels, the lack of a robust and scalable short-selling mechanism may become a blind spot. “Unless this changes,” Kamath warned, “there will always be weird distortions in the prices of Indian markets.”