Capital Market: Theory: Introduction, Concept, Role, Importance, Evolution in India etc.

By Rakesh Sud Financial markets- Lecture 5

Indias regulators have been active in seeking ways

to develop the countrys financial markets, and a culture of introducing greater risk management is starting to set in. The main challenge ahead is to strengthen the political will to further ease regulations in the capital markets and the limits prescribed to market participants. Indias economy is expected to benefit enormously from the process of gradual capital market liberalisation. Empirical evidence has shown that emerging market economies that have heralded changes in their financial markets experienced higher growth and investment. India is no exception, with per-capita GDP and domestic investment rising post-liberalisation. Economies which pursued deeper financial market reforms, and whose per-capita incomes were roughly similar to Indias prior to their liberalisation periods, not surprisingly experienced even greater rewards. Drawing from these countries experiences, Indias growth potential can experience a sustained pick-up if it stays on the path of reforming its capital markets.

Indias regulators have been active in seeking ways

Full capital account convertibility no longer appears to be a pipe dream, going by the RBIs reconsideration of the Tarapore Committees roadmap to capital account liberalisation. Early in 2006, the conditions for full capital account convertibility have been re-examined against issues such as exchange rate management, prudential safeguards to monetary and financial stability and implications of dollarisation in India. Although full convertibility is still not expected to occur overnight, the momentum towards that goal seems to have accelerated.

Capital markets

where stocks and bonds are exchanged serve to raise long term funds for firms and governments: they are essential to economic activity (and growth).

The Indian capital market is more than a century old.

Its history goes back to 1875, when 22 brokers formed the Bombay Stock Exchange (BSE). Over the period, the Indian securities market has evolved continuously to become one of the most dynamic, modern, and efficient securities markets in Asia. Today , Indian market confirms to best international practices and standards both in terms of structure and in terms of operating efficiency. Indian securities markets are mainly governed by a) The Companys Act 1956, b) the Securities Contracts (Regulation) Act 1956 (SCRA Act), and c) the Securities and Exchange Board of India (SEBI) Act, 1992.

The term Capital Market is used in the wider sense as to include both the new IPO market and the stock market. In this sense, both primary and secondary markets are covered here.
Trading in the stock market is debt claims of a medium and long-term nature which can be classified into those of the Government sector and of the private sector. The securities of government are traded in the stock market as a separate component, called gilt-edged market. These securities include those of the Central and State Governments, local bodies, semi-government bodies and those guaranteed by the Government. In this market, there are again three types of securities - short, medium and longdated Government securities, depending on the maturity period. Another component of the stock market deals with trading in corporate securities such as equity shares, preference shares and debentures. Equities are shares of companies of the ownership category. When these equities are floated to the public for the first time by the companies as shares, they constitute the new IPO market, which is a component of the capital market and when the same securities are traded again and again as secondary items, they constitute secondary markets . Derivatives are also introduced in the capital market for the benefits of small and institutional investors.

Change in Capital Market

the Indian capital market has undergone a sea change in the post-independence era. More particularly, the stock (Share) Operations has witnessed a spurt of activities with the liberalization of the economy and active participation of development banks

A capital market is a market

for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds

CAPITAL MARKET
It is defined as a market in which money is provided for periods longer than a year[1], as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market includes the stock market (equity securities) and the bond market (debt).

Capital Markets
Market for borrowing and lending LONG TERM Main Characteristics
Securities Market Security Prices Participants
Financial intermediaries Non Financial Business Enterprises Households Government Banks etc

Functions of a Capital market

Allocation Liquidity Indicative Saving and Investment Transfer Merger

Evolution-Indian Capital market

1947-1973 1973-1980 1980-1992 1992 Infrastructure Stage New Issues Stage SEBI Stage Structural Transformation

Two Markets- Gilt Edged/Industrial Securities

During 2009-10 so far, the Indian capital market outperformed

most Emerging Market Economies , recovering a large part of the household wealth that was eroded by the contagion from global financial crisis. The secondary markets continued to register considerable gains on the back of credible indications of pickup in the domestic industrial activity and emerging signs of recovery in the world economy. The primary market, which had remained subdued up to May 2009 also resumed activity.

During 2009-10 so far, the Indian capital market outperformed

Indeed, a few IPOs were oversubscribed by more than 20 times. Resource mobilisation by mutual funds also increased substantially. The volatility in the stock market during AprilSeptember 2009 was higher compared with the same period of last year arising from intermittent uncertainty regarding global economy and the changing perception about the real impact of domestic monsoon situation.

Gilt Edged or Govt Securities

Guaranteed Return No speculation Institutional Based Investors (mostly forced by Law) Predominated by LIC, GIC, PF, Commercial Banks Heavy volume of transactions

The gilt-edged market refers to

the market for Government and semi-government securities, backed by the Reserve Bank of India (RBI). Government securities are tradable debt instruments issued by the Government for meeting its financial requirements. The term gilt-edged means 'of the best quality'. This is because the Government securities do not suffer from risk of default and are highly liquid (as they can be easily sold in the market at their current price). The open market operations of the RBI are also conducted in such securities.

Industrial Securities
PRIMARY
Public Issue Rights Issue Private Placement

SECONDARY

New Financial Institutions

Venture Fund Mutual Funds Factoring Credit Rating OTCEI NSEI NCDS NSDL SCHIL

NEW FINANCIAL INSTRUMENTS

Commercial paper Certificate of Deposit Secured Premium Noted with attached warrant NCD with detachable equity warrants Zero Coupon Bond Zero Interest Fully Convertible Debenture

Deep Discount Bonds Stockinvest Equipref shares Equity Shares with detachable warrants Pref Shares with warrants Euro Issues Non voting right Shares Other Innovative Instruments

Indian Capital Markets- major Issues

Investor Protection Integration of Stock Exchanges National Stock Market System Science and Technology Derivative Instruments Integration of Capital markets

Reason for Markets Rebounding

Strong Macro aggregates Active retail investor buying FII Buying Indian Inst Investor Buying Favourable Sovereign Rating Good FX Reserves Strong Fundamentals Monsoon/Political Good prospects

Capital Market instruments

Preference Shares Equity Shares Non-voting equity shares Debentures Bonds Cumulative Convertible Preference Shares Company Fixed Deposits Warrants

Latest (post 1996) Capital Market Reforms

Custodial Services Modification of Listing Agreements-Intr after 30 days from closure of public issue Delivery Norms Buy in or Auction Procedures SE to collect 100% daily margins from brokers etc Clearing Corporation set up

Latest (post 1996) Capital Market Reforms

SE not allowed to renew contracts for cash shares between sessions Core Group- study major volatility Screen Based Trading expanded to new areas Clearing Corpn mechanism to handle grievances Removal of limits for OTCEI Stock lending Scheme Introduction

The Indian capital market is integrating with international capital markets.

One of the significant steps towards integrating Indian capital market with the international capital markets was the permission given to Foreign Institutional Investors (FlIs) such as, mutual funds, pension funds and country funds to operate in the Indian markets. Foreign firms have also been allowed to operate in the Indian markets. Indian firms have also been allowed to raise capital from international capital markets through issues of Global Depository Receipts (GDRs), American Depository Receipts (ADRs), Euro Convertible Bonds (ECBs), etc.

Indias capital markets have experienced sweeping changes

since the beginning of the last decade. Its market infrastructure has advanced while corporate governance has progressed faster than in many other emerging market economies. In contrast to several developed countries and Asian economies, Indias capital markets are still shallow, implying that further reforms are needed to make India a world-class financial centre.

Efficient and Safe capital Market

The capital market in India has become efficient and modern over the years. It has also become much safer. However, some of the issues would need to be addressed. Corporate governance needs to be strengthened. Retail investors continue to remain away from the market. The private corporate debt market continues to lag behind the equity segment.

Structural Transformation
The Indian financial system has undergone structural transformation over the past There has been improvement in banks capital position and asset quality as reflected in the overall increase in their

Structural Transformation
Significant improvement in various parameters of efficiency, especially intermediation costs, suggest that competition in the banking industry has intensified. The efficiency of various segments of the financial system also increased.

The major challenges facing the banking sector

are the judicious deployment of funds and the management of revenues and costs. Concurrently , the issues of corporate governance and appropriate disclosures for enhancing market discipline have received increased attention for ensuring transparency and greater accountability. Financial sector supervision is increasingly becoming risk based with the emphasis on quality of risk management and adequacy of risk containment.

Consolidation, competition and risk management

are no doubt critical to the future of Indian banking, but governance and financial inclusion have also emerged as the key issues for the Indian financial system. The capital market in India has become efficient and modern over the years. It has also become much safer. However, some of the issues would need to be addressed. Corporate governance needs to be strengthened. Retail investors continue to remain away from the market. The private corporate debt market continues to lag behind the equity segment.

Latest Offerings
Innovative products such as securitised debt and fund products based on alternative assets are starting to break ground. But an enabling environment is not yet in place and there remains an overriding need to increase domestic investors knowledge regarding the merits and risks of capital market investing. A vibrant, well-developed capital market has been shown to facilitate investment and economic growth. We believe that persistent reforms in the sector can support Indias already impressive growth trend in the coming years.

Government Bond Market

At nearly 40% of GDP, the size of Indias government bond segment is comparable to many other emerging market economies. Its corporate bond market, however, remains small and is dwarfed by those of the United States, South Korea and Malaysia.

The bond market is dominated by government bonds.

Government bond issuances, resulting from persistently high fiscal deficits, as well as specific regulatory requirements, have underpinned the supply and demand conditions in Indias debt capital markets. Nearly 90% of total domestic bonds outstanding are government issuances (i.e. Treasury bills, notes and bonds), squeezing out corporate and other marketable debt securities. Initiatives to lift the corporate bond market from its nascent stages have been slow to progress , leaving companies unable to realise their optimum capital structure as a result. Unlike the derivative instruments that are available for equities, those for fixed income instruments (e.g. options in interest rates) in the organised exchanges have failed to take off, limiting the price discovery in the secondary markets.

Secondary Equity Markets

India boasts a dynamic equity market. The sharp rise in Indias stock markets since 2003 reflects its improving macroeconomic fundamentals. However, the large size of insider holdings and the small presence of institutional investors belie these impressive figures.

Secondary Equity Markets

These positive dynamics have led to a sustained surge in Indias equity markets since 2003, attracting sizeable capital from foreign investors. Net cumulative portfolio flows from 2003-2006 (bonds and equities) amounted to USD 35 bn. Moreover, Indias stock market has outperformed world indices in recent years. Despite its increasing correlation with world markets in recent years, India still offers diversification in global portfolios.

4 Essential Readings to Refer

India's Financial Markets An Insider's Guide to How the Markets Work By Ajay Shah, Susan Thomas, Michael Gorham Elsevier Financial Markets and Institutions 3rd Edition By Dr S Guruswamy, Tata Mcgraw Hill Education Pvt Ltd Financial Institutions And Markets - Structure, Growth and Innovations 5th Edition By L M Bhole, Jitendra Mahakud Tata Mcgraw Hill Education Pvt Ltd Financial Institutions and Markets Second edition Mein Kohn Oxford University Press