Professional Documents
Culture Documents
CHAPTER VII
and securities finance. They are like three legs of a stool- stable if they complement
the needs and size of our country budgetary policy has real limitations. Bank finance
through the intermediation of banks helps project realisation, with a multiplier effect.
However, it is an indirect form of finance where banks are made to shoulder market
risk. In sharp contrast, securities finance or capital market finance is a direct form of
Europe and North America feature highly developed financial system and stock
market that performs the resource allocation function much more efficiently than
budgetary finance. It is true that experiences of developed countries need not suit the
the contributions stock market finance and probe into its future prospects. It is in this
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milieu that the findings of the present study are discussed and policy implications
chalked out.
Indian stock market is miserably low. Theoretically, stock market investment aims at
manner. It, therefore, requires the existence of a relatively large number of investors
with the sophistication, means and ability to shoulder such risks. However,
and excessive speculation are still a nightmare to genuine investors in the country.
People do not consider stock market as formal financial institutions like banks. Instead
it is treated as a gambling place for speculators. Serious policy initiatives are required
FII flow is the major factor behind the remarkable surge in turn over and
liquidity of Indian stock market since the past ten years. Besides, the movements of
major stock indices are in tandem with trends in FII flows, and they have become the
most crucial single factor influencing stock market behaviour nowadays. However, in
a long term perspective FII inflow is more likely to plateau out when interest rate
better participation of domestic financial institutions that have large funds to invest
pension funds to invest in the stock market, further steps should be taken to expand the
participation in various derivative instruments also should be allowed for the long
Indian stock market exhibits positive changes with regard to various aspects of
the market. Equity volatility of Indian stock market has come down significantly from
1995 on wards. India exhibits lowest variation in stock returns among emerging
markets. Contrary to the popular belief, stock market volatility in the Indian stock
market has not increased after opening it up to FIIs. Similarly, market concentration,
and transaction costs have come down in major stock exchanges in the post-reform
period. India’s position in this regard is better than many advanced capital markets.
Indian stock market is still a fragmented market. There are twenty three stock
exchanges in the country of which three are national exchanges. Seventeen exchanges
of existing exchanges. NSE has already provided connectivity to more than hundred
cities and other major exchanges are also extending their trading terminals outside the
area of their operation. In fact the relevance of regional exchanges has decreased with
the advent of nation-wide trading network. In this context having a large number of
questionable.
market are fragmented. SEBI has been delegated most of the functions and powers
according to the SC(R) A, and shares the rest with the Ministry of Finance. It has also
been delegated some functions under the Companies Act. RBI also has regulatory
involvement in the stock market with respect to foreign exchange liquidity control.
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Though fragmentation of regulatory environment has not been a major obstacle yet, it
The size of the stock market, measured as the market capitalisation ratio does
not seem to affect the growth prospects of the country. The nature of relationship is
also not conclusive. However, stock market size shows significant positive
relationship with the level of industrial activity in the country. This finding is
consistent with the earlier studies (Levine, 1993), that suggests that stock market size
growth and the index of industrial production. But this relationship is statistically
weak. Stock market efficiency shows statistically significant positive association with
economic growth. It shows weak positive association with the index of industrial
through the reduction of transaction costs and other imperfections associated with
equity finance. This finding indicates that various measures implemented towards
weak in some cases, is an indication of the nexus between the services provided by
stock market and long run economic growth. It is also noteworthy that the results do
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not support the view that stock market development is detrimental to long-term
economic growth.
economic variables such as M3, PLR, and IIP. This indicates that stock markets are
not mere centres of speculation, but meaningful institutions that bear a close
Granger causality tests show that there is unidirectional causality running from
both stock indices to M3 and PLR. Hence it can be concluded that stock market leads
these monetary variables in India, rather than being led by them. This finding is all the
more significant in the backdrop of increasing use of asset prices as signals for the
conduct of monetary policy worldwide. Since there are cointegrating relations between
stock prices and these monetary variables, stock prices can also be used as devices of
between Nifty and the index of industrial production. This supports the theoretical link
to M3 and PLR is that both the stock markets (BSE &NSE) are efficient with respect
to these two variables. This finding provides strong evidence for the presence of semi-
strong form efficiency of Indian stock market. Present information regarding PLR and
M3 are being reflected in both the indices perfectly, and past values of these variables
cannot predict the future value of stock indices. In the wake of wide fluctuation in
stock prices, this finding has special significance. Since stock prices adjust to present
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information about PLR and M3 quickly, monetary authorities can use them to create
Indian corporate sector in recent years, especially since 2003. This finding about
capital structure of Indian firms is novel, since studies prior to 2003 concluded that
Indian firms are more reliant on external finance. Singh and Hamid (1992), and
Samuel (1998) argued that the absence of informational asymmetries in the Indian
economy due to its bank-based financial system has been a major reason for the
increased external dependence of Indian firms. This paradigm shift from external to
internal finance has taken place due to the increased use of retained earnings. The
results also show that among various external sources, firms still prefer bank
It is found that companies do not raise a substantial amount of finance from the
stock market in India. On a net basis, the contribution of stock market accounts to 13.3
per cent of total finance. It is found that firms have made use of the two stock market
booms during 1993-94 and 2001-02. However, there is no sustained rise in the
proportion of equity finance during the study period. Over these years the dependence
of Indian corporate sector on stock market has declined from 18.9 per cent in 1992 to
6.1 per cent in 2005. This is in contrast with the general proposition that, as
financing.
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Another robust finding of the study is that, small and medium size firms are
considerably more reliant on external finance than large firms, and obtain a greater
share of funds from stock market and a lesser share from banks and other financial
institutions. Similarly, for young firms stock market funds still constitute a major part
of total external finance used. As the firms grow, the share of borrowings increases
and that of equity finance decreases. This contrasts the general view that stock
markets better serve old and established firms, typically with large tangible assets.
The relationship between stock market financing and external debt is not
funds and external borrowings in most of the samples, and it is highly significant in
some cases. This refutes the findings of previous studies that equity and debt finance
are complements. However, the substitution is not perfect, since in some cases the
debt-equity ratio of firms. Larger the size of the stock market, lesser the leverage of
firms. This finding indicates that stock market size and borrowings are inversely
related in India. Stock market size is positively and significantly related to the
demand for equity capital by firms. Larger size of stock market encourages greater
Cost of equity shows a strong positive association with leverage. Greater cost
of raising equity leads to larger use of borrowed funds. Further, the cost of equity is
found to be negatively and significantly associated to the demand for equity capital,
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even after controlling for the size of stock market. It indicates that even if stock
market is large in size, high cost of raising funds will adversely affect firms’ demand
Stock market efficiency shows negative, association with debt-equity ratio and
positive association with demand for equity capital. However, the relationship is not
statistically significant in either case. It indicates that stock market efficiency is not a
The level of liquidity of the stock market bears strong negative association
with debt-equity ratio. It implies that existence of liquid stock markets helps to reduce
the level of leverage of firms. Stock market liquidity is also found to be positively and
significantly related to firm’s demand for equity capital. It supports the view that
liquid stock markets ease the risk associated with long term commitment of capital and
The results indicate that large and liquid stock markets are instrumental in
shaping the capital structure of corporate firms in India, even after controlling for
other major determinants of corporate capital structure. Larger and more liquid the
stock markets are, larger will be their demand for equity capital and smaller will be
their dependence on leveraged funds. This finding refutes results of earlier studies that
equity ratio and thus more business to banks (Demirgüç -Kunt and Maksimovic,
1995). Another interesting point is that this behaviour of debt-equity ratio in India is in
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tune with that of developed countries, where development of stock market leads to a
important in the mobilisation of savings, the study reveals that 78 per cent of the
investors prefer to get shares from the secondary market rather than from the primary
market in the country. The abolition of Capital Issues Control and replacing it by a
free-pricing system in 1992 is the major factor that led to the erosion of public trust
in the primary market. The lack of proper regulation facilitated the flotation of a large
number of unsound and even fraudulent companies. The widespread bad experiences
led to withdrawal of the investors from the primary market for many years after the
mid-1990s.
Not only small investors, but large public organisations with enormous funds
like the Employees Provident Fund Organization (EPFO), are not allowed to invest in
stock market because of its erratic and risky nature. Hence healthy functioning of
stock markets should be ensured to induce such organisations and small investors to
invest larger proportion of their funds in equities. The present design of the Indian
behaviour is characterised by too much price volatility and manipulation, which are
the biggest worries of ordinary investors. However, the authorities are not worried
until a market crisis emerges. The objective of the regulators should be to build a
stock market system which will benefit the economy as well as the mass of investors
most productive uses from the economy’s viewpoint, rather than fulfilling the animal
It is found that majority of the investors surveyed belong to the urbanised parts
of the respective regions. This indicates that stock market investment is still an urban
phenomenon. There is potential for increasing the investor base by increasing rural
The study shows that a vast majority of the investors first entered the stock
market after the age of 35 years. Only a minority of 7 per cent first entered before the
age of 35. Generally the first investments by young people take the form of bank
deposits and life insurance policies which need no prior understanding. People often
refrain from investment in shares since some learning is necessary for successful stock
market investing. Such unfamiliarity affects the confidence level of investors in future
also. Hence, suitable educational programmes for investors are essential. Such
It is found that a majority of retail investors do not regard mutual fund equity
of the surveyed investors invest in shares through stock market only. Only 38 per cent
subscribe to shares both directly and through mutual funds. This is so despite the
theoretical advantages claimed by advocates of mutual funds. The AMFI too has
revealed that households are not allocating their savings to to the mutual fund
schemes, particularly equity schemes. Mutual funds being more safe instruments, it is
necessary to attract more investors towards them in order to create a positive impact
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upon their income and savings. Further research towards this direction is needed to
find out the various reasons for the disenchantment of investors with mutual fund
products.
significantly during the past ten years. Among the factors contributing to this
access to trading, and efficient intermediation. This indicates that stock market
reforms and resultant development of the stock market have created favourable impact
on the investors. The reduction in the transaction costs, establishment and promotion
of market intermediaries such as NSDL, CDSL, introduction of NSE and screen based
trading has succeeded in increasing the participation of retail investors in the stock
market. However, the factors that got the least rankings- better return from investment
and low risk of fraud point towards the weaknesses of the present system. Majority of
the investors opined that return from equities does not increase over these years.
Unwise investment decisions and wrong timing of buying and selling by investors
market behaviour can help improve return from stock market investment.
Despite the various regulations implemented to make stock market more fair
and credible institution, fraudulent practices and excessive price volatility are still the
biggest worries of majority of the retail investors. Similarly, tax benefits, a factor
which is included in the questionnaire but omitted from further analysis because of
negligible rankings received, need serious attention. While many other financial
instruments attract investors with benefits of tax concessions, equities fail to attract
investors who seek tax benefits from investment. Since mobilisation of savings
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through equities helps capital formation and growth, more tax concessions should be
extended to return from equities, which will eventually help to widen the retail
investor base.
The study reveals that stock market development is not instrumental enough to
raise fresh savings from the investors. The increase in the proportion of stock market
investment out of total saving is mostly financed by diversion of funds from other less
profitable investment rather than by increasing savings. This indicates that stock
market development has not played any significant role in enhancing savings. The
increase in the amount raised through stock market mainly constitutes funds diverted
from other means of assets. The fall in the interest rates on bank deposits and
government savings schemes has led to a greater inclination towards equity shares.
Other than such transferred funds, stock market’s contribution to fresh saving
providing tax concessions to equity investment also will be instrumental to raise more
household savings.
Another major finding is that 70 per cent of the investors make investment
and risk hedging decisions on the basis of own experience. This point towards the
need to impart better investor education so as to reduce loss due to unwise decisions
and resultant withdrawal of investors from the market. A large number of investors
unwise stock selection. Many of them lack a historical understanding of the stock
From the open ended question about the measures to improve stock market
and excessive volatility. Such unruly market behaviour has the effect of discouraging
or even driving away the genuine investors from the market. Since the study reveals
that 81 per cent of the respondents are first generation investors, it is essential that the
trust of investors in the stock market should be maintained in order to widen the
investor base of the stock market, and to ensure sustained flow of funds to the stock
market
institutions like provident funds to invest into the stock market. The current level of
investors in the stock market. For this, investment management should be included
in the curriculum during the years of schooling itself. Similarly for undergraduate
to make them aware of the behaviour of stock market and management of risk
4. The study has found that small and medium size firms and young firms are more
dependent on stock market than large and established firms. Hence steps should be
taken to develop SME specific trading platforms like BSE Indonext, so as to enable
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capital formation by SME companies from the stock market and help develop
5. Further reforms in stock market should aim at enhancing the efficiency of the
market, since it is found to be more robustly related to long run economic growth of
the country.
6. To control the concentration of turnover and price volatility, benchmark indices like
10. Primary market should be made more dynamic by making pricing of shares more
credible, IPO rules less cumbersome, and disclosure norms more alert.
11. Investors should be attracted towards mutual fund investments by giving more
incentives.
12. Stock markets should be made more formal financial institutions by cubing
excessive speculation and other fraudulent practices. For this better disclosure
regard.
The relationship between stock market and real economy is a comparatively less
researched area in India. Even in the international level, interest in this subject evoked
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only in the 1990s following a wide effort by World Bank to explore the link between
firm-level case studies were made in many parts of the world exploring the functional
link between stock market and the economy. However, the applicability of the findings of
these studies differs among countries depending on the level of development achieved
and the pattern of economic policies adopted. Separate studies taking into account the
economic condition of each country is essential to frame suitable policies in this regard.
The study identifies the following areas of future endeavour for researchers interested in
this field.
There is little evidence for the link between stock market development and
corporate growth, and legal framework in the Indian context. Event studies that examine
the impact of various fiscal and monetary events are also at infancy in the country.
Similarly, very few attempts are made to study the impact of stock prices on the real
sector, and the use of stock market dynamics in the conduct of monetary and fiscal
policies. Another area with extensive research possibility is the impact of foreign
Considering the history and present development of the stock market in the country, the
volume of research done is so inadequate and there is ample scope of further research.