Is a stock market failure on the cards? The thought may sound grim and far-fetched but it may not be far from the truth.

Stock brokers in Mumbai are fearing a severe liquidity crunch in the market beginning April, which may lead to a broker crisis, arising out of distress sale in the end of the current month.

One broker has already closed shop before the crisis could hit him, but the more sanguine - not-so-smart operators, from another point of view - may see a crisis before they go bust, market sources said.

There are about three brokers rumoured to be on their way to severe liquidity crunch.

According to market sources, at present the arbitrage trade between the two major exchanges - the Bombay Stock Exchange and the National Stock Exchange - account for more than 50 per cent of total turnover.

These trades are done at wafer-thin margins of 5-10 paise and any rise in the cost could kill the arbitrage trade, the lifeline of the stock market.

"We are apprehensive of the increase in stamp duty, which may totally wipe out the arbitrage between the exchanges," a broker said.

The Maharashtra government is contemplating a 500 per cent increase in the stamp duty from April 1, 2003, from 20 paise to Re 1 for every Rs 10,000 traded.

Even though it has indicated that there may be a review of the decision, nobody is sure whether it will actually opts for the status quo.

The broking community feels doomed with Maharashtra's proposal to restore the stamp duty on stock market transactions to Rs 1000 per Rs 1.00 crore from the current rate of Rs 200 beginning April 2004.

The stock brokers are currently operating at a meagre 3-5 paise brokerage.

Some have even turned into discount brokerages. It is difficult for the brokers to raise the brokerage charges, sources said.

"While it will have a murderous impact on retail and client trades, the proprietary traders profitability will also be wiped off," he added.

This will lead to a reduction in intra-day volatility again paring the marginal spreads between the markets causing a shrinkage in liquidity.

Besides, this will also drastically reduce the arbitrage between derivatives and cash markets, having a drying impact on opportunity trading.

"Mumbai alone accounts for about 40 per cent of such stock market transactions. Any rise in cost due to stamp duty will have a severe negative impact," says Sandeep Presswala, vice-president, Investsmart India.

While the overall rise in cost for hedgers between the options and futures market would be lower at about 30 per cent, the cost for traders in purely futures segment would be 500 per cent.

The stamp duty on options is charged on the premium, while it is charged on the full amount of trade in the futures segment.

The futures segment account for 74 per cent of the average daily derivatives turnover of Rs 2,621.75 crore as against a 26 per cent share of the options segment.

"With the rise in cost, the beta spread would increase and the prices may be butchered leading to panicky situation to squaring off positions when the derivatives contract are due to mature on March 27," a broker explained.

Brokers and traders will have to start squaring up their positions before the month-end nears and would not get the opportunity to roll over the position to April futures.

Since most mutual funds are fully invested and have only hedging positions in the market, there would be no buying support to match the selling pressure, taking the prices to a pit.

"This is a national issue as far as capital markets are concerned since more than 50 per cent trade is generated from Mumbai. The reduction in liquidity has historically led to broker failures - if not exchange failures - and the government has always acted as fire fighters after the crisis breaks out. Hope this time, the government acts fast," an apprehensive player said.