CHAPTER Vl-Caoital Market and Economy:A Linkages

6.1 Objective:

> The objective of the chapter is to look at the linkages between the economic

barometers and its co-relationship with the capital market performance.

> There has been a number of initiatives that has been made on the economic policy

front, liberalization of the financial sector, credit reforms and external reforms. A

brief description is made of all these policy initiatives taken over the years in this

chapter.

> The importance of the Stock Market in the economic development is exhibited

and then relationship that exists between the numerous economic parameters and

the market performance is brought out.

6.2 Stock Market and Economy

The worldwide trend in the twentieth century towards greater self-regulation

accompanied by tighter Govt, controls. In view of the fact that the stock exchanges

and securities trading involve an element of speculation and risk taking, which may if

uncontrolled destabilize the markets, control on stock exchanges is considered

necessary. But a degree of speculation is necessary as to provide liquidity to the

market.

Functionally stock exchanges help in mobilizing saving for investment in the

economy and provide liquidity through their marketability. Stock exchanges are thus

windows to the economy and a barometer of the performance of the economy.

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If they have to perform this function, the stock exchanges themselves should be quick

to respond to the demands of the public of the economy.

In macro aspect the stock market is window of the economy in the capitalist market

oriented countries. Mobilisation of resources through issue of securities, borrowing

and lending in the organized sector of the economy are the functions and activities in

the stock market. The financial resources raised through the stock market if used for

investment and for productive activities, would generate further outputs and incomes

of the people and promote growth. Thus economic growth and activities in the stock

market are closely related.

The major borrowers in the stock market are the corporate sector and the Govt. Sector

who spend more than their income and invest more than they save. The lenders are

the household sector and the foreign sector in case of India as they have positive

savings and net surplus to lend. These four-sectors are related very closely to the

economy and financial system shown below.

The great depression of 1929 and the Wall Street crash at that time left bitterness in

the USA, which sought to be made good by greater Govt, controls. The establishment

of Securities and Exchange Commission in USA and similar bodies in other countries

were the offshoot of such crashed in the stock market. They were set up to survive

and promote the trading in securities without unfair trade practices. The laws passed

after the wall street crash and the reforms in their practices since 1975 in the USA and

after the Big Bang 1986 in UK were examples of how the stock exchange movement
Page 126 of 163
was set on right lines in the foreign countries. But the experience in other countries

was no guide to India, as the Indian Stock Markets as far insulated from foreign

influence due to strict foreign exchange and trade controls before 1991-92.

It was only since 1985 with the entry of banks and their subsidiaries into the stock

and capital markets facilitated, by the passage of the Banking Laws Amendment Act

1983, that the idea of better services in these markets arrives. The seventh five-year

plan 1985-90 contained the first elements of a new economic policy leading to the

opening up of the economy, industrial liberalization and a growing role of the Private

Sector. This necessitates greater attention to the growth of capital market and

protection of investors as public interest in these markets began to grow.

The liberalization process started after 1991-92. In July 1991 new economic policy

reforms were started by the Finance Minister Dr. Manmohan Singh aimed at macro

economic stabilization, structural adjustment and restoration of economic health.

Industrial licensing was abolished except for 18 selected special categories of

industries. The MRTP act was amended to remove the asset limit of MRTP

companies and dominant companies thereby enabling them to expand their activities

and investment. Foreign direct investment through equity participation was increased

to 51% in selected industry groups. The entry and exit foreign investment and foreign

collaboration were made easier. FERA was liberalized and export promotion became

the main plank of new trade policy. Rupee was partly convertible in 1992 and fully

convertible in 1993.

127 of i«
Rupee was first devalued by around 20% in July 1991, followed by abolition of cash

compensatory support scheme. To help exports to have incentives to grow new

scheme of exim scrips to exporter was introduced. These were made transferable and

tradable and entitled the holder to freely import of foreign goods needed for domestic

production.

This export incentive scheme was made unnecessary when early in 1992; the rupee

was made partially convertible up to 60% of the export proceeds. The rest of the 40%

were to be sold to the banks at the official rate by exporters. Later in 1993 Feb, rupee

was made fully convertible to boost the exports.

In the trade policy, imports on GGL were liberalized; duties on various types of

exports and imports were reduced or abolished. The free import policy would help

industries dependent on imported inputs to grow faster. Similarly free convertible of

rupee would augment exports and export oriented Units would prosper.

These measures of trade policy have bearing on the corporate profitability and

encourage foreign completion with domestic companies and promote a market

oriented economy competition. Efficiency and productivity will promote the Indian

corporate sector and that will help the stock market.

After liberalization policy frame in 1991-92, the economy grows faster. This will

affect the stock market. After liberalization foreign investors come largely to the

Indian companies. They finance capital to the large-scale corporate sector so that the

production is increased. The companies are able to export the product in large scale to
the international market. The companies demanded more capital from FIIS,

institutional investors and different financial institution through stock market so that

the turnover in the stock market is increased rapidly. Take an example; the total

turnover of the BSE was Rs 4796 crores in 1984-85 that rose to Rs 36,012 crore by

1990-91 and then doubled to Rs 71,777 crore in 1991-92.

Indian economy for over 3 decades after independence was dominated by the public

sector that was considered as the major vehicle for economic and industrial

development. The trade has however changed since the mid 80s with liberalization of

Govt, policies and grater freedom given to the private Sectors, in most of the sectors,

including the basic sector comprising iron and steel power and road construction

among others. The policy of progressively deregulating the economy has had to the

emergence of stock market as major instrument of finance for industry and Trade.

The Indian economy during the eighties had grown at a much faster rate and the

average growth rate was 5.5%. In the nineties the economy touched a growth rate

about 6.5%. Due to the growth of economy, the savings of the people also increase.

Due to more savings the people go to the stock market to get more benefit in a quick

period. So the demand for shares was increased. This was reflected in the stock

market index increased rapidly,

Indian securities market is getting increasingly integrated with the rest of the world.

Indian companies have been permitted to raise resources from abroad through issue of

ADRs, GDRs, FCCBs and ECBs. ADRs/GDRs have two-way fungibility. Indian

129 of 163
companies are permitted to list their securities on foreign stock exchanges by

sponsoring ADR/GDR issues against block share holding. NRIs and OBC are allowed

to invest in Indian companies. Fils have been permitted to invest in all types of

securities, including government securities. The investments by Fils enjoy full capital

account convertibility. They can invest in a company under portfolio investment route

upto 24% of the paid up capital of the company. This can be increased up to the

sectoral cap/ statutory ceiling, as applicable, provided this has the approval of the

Indian company’s board of directors and also its general body. Indian stock

exchanges have been permitted to set up trading terminals abroad. The trading

platform of Indian exchanges is now assessed through the Internet from anywhere in

the world. Mutual Funds have been permitted to set up off-shore funds to invest in

equities of other countries. They can also invest in ADRs/GDRs of Indian companies.

In 1990 the industrial sector had grow faster due to more production. They go to the

stock market by shares and debentures. The publics were aware of the profitability of

the different industrial sector. The public demand more shares or debentures of those

companies whose profits are more, who paid more dividends, so the demand for

industrial securities are go the high. So when the supply of securities are low and

demand is high the price of the securities are also high. This will come under law of

demand and supply.

The stock market indexes, which will be prepared by different institutions go to the

high. The market capitalization and turnover in the market is high. The boost in the

sensex or index reflects the growth on the stock market. Due to the growth in the

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stock market, foreign institutional investors come to the Indian economy. So the

investment in the economy is increased. Due to the growth in the economy i.e.

production, service sector, the employment is also increased. The industrial sector

demand more skilled labour for the production or service. So the unemployment is

down. Due to the more employment the standard of living of the people increased.

When the standard of living of the people increased, the saving also increased and

demands more income from savings by investing in Govt, or industrial securities. For

purchase of Govt, or industrial securities they go the stock market. So the prices of

securities increased in the stock market is healthy.

So after liberalization, the production sector, and the service sector are grown faster.

When the economy is on high, the demand for capital is increased. The capital comes

from the primary market secondary market. The demand for capital is increased in

secondary market i.e. the stock market. So the stock Market is the barometer of an

economy or Mirror of an economy. So when the economy grows the market grows or

vice-versa.

But according to the great economist Dr. Amartya Sen we do not think that the

growth in the stock market is the growth of the economy. Because if we do not

decreased the number of people below poverty line the growth of the stock market

has no value. So first, we take action how to minimize the poverty. If we minimize

the poverty then the economy grows faster and also the stock market is in healthy

position.

131 of 16:
The Indian economy has about 4.5 per cent per annum on an average in the second

half of twentieth century. It grew by about 3.5 per cent per annum from 1951 till the

mid 1970s. The GDP growth picked up to about 5.5 per cent thereafter till early 1990.

It suddenly dropped to 0.8 per cent in 1991-92. In the same year the growth rate of

agriculture and industry touched - 2.0 and 0.6 respectively, inflation was increased to

13.7 per cent.

The immediate economic causes of the crisis of 1991 were; a sudden drying up of

inward remittances, trouble in West Asian Markets due to the Gulf War and the

collapse of the Soviet economy. Thus India lost the support of its largest trading

partner. Moreover, domestic political instability accentuated the economic troubles,

as critical decisions got postponed and fiscal discipline lessoned. Due to the financial

crisis India approached the World* Bank and the International Monetary Fund (IMF)

for financial help. They agreed to provide funds but under the condition that India

must follow their prescription regarding the structural adjustment programme and

economic reforms. Subsequently in July 1991, major economic reforms were

announced in the area of industry, trade, banking, capital market etc. Further the

Government resolved to globalise the economy and make it more competitive in the

World. In this era of delicensing and deregulation many private and public sector

units are coming up from within the country and abroad , to boost the

industrialization.

To support this,! the financial sector reforms also have taken place. Reforms in the

banking sector are aimed to strengthen the banking system by enhancing their
Page 132 of 163
efficiency and competitiveness. Capital market reforms have undertaken to attract

more and more domestic as well as foreign investors. Efforts are made to boost the

capital market so that the corporates can raise funds easily, with better price at less

cost. On the other hand the investors are provided with more liquidity, transparency,

better trading facilities etc. The reform made to introduce derivatives, provide the

investors the most needed equipment to hedge risk and lessen the magnitude of loss in

the capital market.

The reforms in Indian economy called for paradigm shift in economic thought. The

economic idea, which was rooted in four decades of centralized planning and pseudo­

socialism was aimed to remove the focus of the first of the reforms, are given below :

• Gradual shifting of the concept of the resource allocation from centralized to

market based;

• Simplification in direct and indirect tax structure;

• Banking sector reforms, aimed to lessen the burden of social banking, inefficiency

of operations, regulated interest rates, pre-emption of funds through excess

reserve and huge non-performing assets (NPAs);

• Opening up the path of foreign direct investments (FDI) and foreign portfolio

investments (FPI);

• Financial sector reforms;

• To build financial institutions and infrastructure relating to audit and legal

framework;

Page 133 of 163

 • To improve the level of managerial competence and the quality of human

resources;

• To promote competition through a level playing field and freer entry and exit in

the financial sector; and

• To develop transparent and efficient capital and money markets.

6.3 Liberalisation of Indian Financial Market

Financial liberalization stimulates the economic development by making both

securities market and banking sector efficient. It performs the vital function of rising

funds for, and channelling funds to productive investments. Thus, successful financial

liberalization is usually an important component of a country’s strategy for economic

growth. In India we have both organized and unorganised financial system.

Broadly, the financial system comprises of: Reserve Bank of India (RBI), commercial

banks, development banks, co-operative societies, Government sponsored institutions,

private/joint sector institutions, stock exchanges etc. Unorganised market is not

controlled by RBI directly. In this area there are a number of indigenous bankers,

moneylenders, traders, landlords, private finance companies, Nidhies, Chit funds and

a host of other unincorporated bodies. Some activities like deposit taking, maturity

and interest rates on their deposit etc. are controlled by the RBI and the Government.

There links between the organized system and unorganized system. Both commercial

and co-operative banks play an important as the links between these two segments of

the system.

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 We know that the allocation of funds (i.e. savings of households) for the purpose of

investment is crucial function of the financial system. We have two alternative

mechanisms through which such allocation of funds can be done. One is via banks

and financial institutions and the other is via financial markets (viz. capital market).

For a long period, Indian financial system was dominated by banks and financial

institutions. But in the last decade, the market has been rising as an alternative route

for resource allocation. The fall credit is going to our policy markers. They have

prescribed many spectacular reform measures to broaden our financial sector and

globalize our financial market. In modem sense financial market includes the foreign

exchange market, fixed-income market and equity market, as well as the new growing

markets for derivatives securities such as futures, options and swaps.

6.4 Reforms in the financial Sector

Reforms undertaken in the financial sector can be grouped under the heads like credit

reforms, external sector reforms and capital market reforms.

A brief account of these reforms are outlined below:

6.4.1 Credit Reforms

• For term-loans, development financial institution (DFI) free to change any

interest rate above a specified floor.

• Waiving of prior approval requirement for commercial paper (CP) issues.

• Process of phased reduction in statutory liquidity ratio and cash reserve ratio

begins.

• Interest rate structure simplified.

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 Entry of private sector banks allowed.

Maximum permissible bank finance (MPBF) norms made more flexible.

Maximum maturities for CP raised to 1 year.

Convertibility clause no longer obligatory for assistance sanctioned by DFI’s.

Banks free to set their own prime lending rates (PLRs).

Private sector mutual funds allowed to participate in call money market.

Ceiling on term-loans extended by banks lifted.

Loan system of bank credit introduced.

Interest rate ceiling on deposits with non-banking finance companies (NBFCs)

lifted.

• Banks permitted to fix deposit rates on deposits with maturities over 1 year.

• CP freed from the constraints of credit limit.

• Banks directed to announce PLR bond.

• Loan component of working capital finance increased to 75 per cent.

• MPBF concept abolished.

• Consortium lending not mandatory.

• Restrictions on short-term deposit rates lifted.

• Minimum CP maturity lowered to 30 days.

• Scheduled commercial banks are eligible for export credit reference facility at

the bank rate (i.e. 8 per cent p.a.).

• General refinance facility is to be replaced by a collateralized lending facility.

136 of 163
6.4.2 External Sector Reforms

• Rupee made partially convertible on the current account.

• Unrestricted booking and cancellation of forward contracts permitted.

• Corporate with cross currency covers allowed to split exposures

• Dual exchange rate system phased out.

• Companies allowed to access international capital market through Euro-issues.

• Scheme for post-shipment export credit denominated in foreign currency

introduced.

• Banks allowed to raise deposits under the foreign currency non-resident bond

scheme.

• Corporates permitted to hedge exposures with currency options.

• Euro-issue guidelines announced.

• Rupee made fully convertible on the current account.

• Selected financial institutions allowed to make Euro-issues on behalf of small

and medium sized companies.

• Ban or foreign currency convertible bonds lifted.

• Banks given freedom to decide their own foreign exchange overnight positions.

• Banks allowed to provide foreign currency denominated loans to corporate.

• Authorized dealers permitted to offer swaps, interest rate options, and forward

rate agreement.

• Authorized dealer permitted to run swap books.

• Time-table for capital account convertible announced.

Page 137 of 163

 • No end-use restrictions on external commercial borrowing 10 years or more.

• Unlisted companies are permitted to float Euro-issues under certain conditions.

• End-use restrictions on GDR/ADR issue proceeds have been removed except

those on investment in stock markets and real estate.

• Authorized dealers have been permitted to provide forward to FLLs in respect of

their incremental equity investment in India.

• Transactions among Fils with respect to Indian stocks will no longer require

post facto confirmation from the RBI.

• 100 per cent FII debt funds have been permitted to invest in unlisted debt

securities of Indian companies.

• New bill for Foreign Exchange Management Act (FEMA) to replace FERA,

introduced in parliament.

6.5 Dependence of All Segments Economy on the Securities Market

Three main sets of entities depend on securities market. While the corporates and

government raise resources from the securities market to meet their obligations, the

households invest their savings in the securities.

TABLE-12jDependence of corporate sector, central government and state

government on capital market in financing their deficit (as a % on
total deficit)
Year Corporate Fiscal Deficit of Fiscal Deficit of State Govt
1990-91 19.35 17.9 13.6
1991-92 19.17 20.7 17.5
1992-93 33.38 9.2 16.8
1993-94 53.23 48 17.6
1994-95 44.99 35.2 14.7
1995-96 21.67 54.9 18.7
 Year Corporate Fiscal Deficit of Fiscal Deficit of State Govt
1996-97 22.12 30 17.5
1997-98 28.16 36.5 16.5
1998-99 27.05 60.9 14.1
1999-00 33.58 67.1 13.9
2000-01 31.39 61.4 - 13.8
2001-02 N.A 69.4 15.2
Source: Economic Intelligence Service - Corporate Sector, CMIE & RBI

Corporate sector:

The 1990s witnessed emergence of the securities market as a major source of finance

for trade industry. A growing number of companies are accessing the securities rather

than depending on loans from FIs/banks. The corporate sector is increasingly

depending on external sources for meeting its funding requirements. There appears to

be growing preference for direct financing (equity and debt) to indirect financing

(bank loan) within the external sources. According to CMIE data , the share of capital

market based instruments in resources raised by corporate has increased from 19.35%

in 1990-91 to 31.39% in 2000-2001.

Governments:

Along with increase in fiscal deficits of the governments, the dependence on market

borrowings to finance fiscal deficits has increased over the years. During the year

1990-91, the state governments and the central government financed nearly 14% and

18% respectively of their fiscal deficit by market borrowing. In percentage terms,

dependence of the state governments on market borrowing did not increase much

during the decade 1991-2001. In case of central government, it increased to 69.4% by

2001-02. The central government and the state governments together borrowed Rs.

110,510 crore from market during 2001-02 against Rs. 10,557 crores in 1990-91.
Page 139 of 163
 TABLE-13; Resource mobilisation from the primary market (rupees crores)
Issues ‘93-94 ‘95-96 ' 9697 ‘97-98 ‘98-99 ‘99-00 ’00-01 ’01-02
Non-government public 19330 16075 10410 3138 5013 5153 4890 5692
limited companies
PSU bonds 5586 2292 3394 2982 - - - -

Government 819 1000 650 43 - - - 350

Banks and financial 3843 3465 4352 1476 4352 2551 1472 1070
institutions
Private placement 7466 13361 15066 30099 49679 61259 67836 64950
total domesth issues 37044 *6193 *3872 *7738 '9044 >89(»3 74199 72061
Euro issues 7454 496 3275 4387 1148 3487 4197 2342
lulnl capital issues 44408 *6689 *7147 1212? i0192 72450 78.*96 74403
Source: RBI

The above table shows the dependence and the ever-increasing mobilisation from the

primary market. The funds mobilised from the primary market obviously get

channelled to the productive avenues of generating goods and services.

There has been a marked increase from 44498 crores in 1993-94 to 72450 crores in

1999-00 representing a 62.8% rise over a six years time frame which is remarkable by

any standards

6.6 Concepts of Share holders Wealth

ECONOMIC VALUE ADDED (EVA): Traditional approaches to measuring

“Shareholders Value Creation” have used parameters such as earnings capitalisation,

market capitalisation and the present value of estimated future cash flows.

Extensive equity research has now established that it is not earnings per se , but

VALUE which is important. A new measure called “Economic Value Added” (EVA)

Page 140 of 163

is increasingly being now applied to understand and evaluates shareholders wealth

and corporate performance.

E0VA= Net operating profit after taxes (NOPAT)- Cost of Capital Employed(COCE),

where,

NOPAT = Profits after depreciation and taxes but before finance costs. NOPAT, thus

represents the total pool of profits available on an ungeared basis to provide a return

to the lenders and shareholders.

COCE = Weighted average cost of capital (WACC) xAverage Capital employed

To arrive at the COCE, the cost of debt (kd) is taken at the effective rate of interest

applicable to that particular company, which should be a mix of the short term and

long terms debts, net of taxes.

The cost of equity (ke) is the return expected by the investors to compensate for the

variability and the volatility in returns caused by fluctuations in earnings and share

prices

The Cost of Equity (ke) = Risk free return equivalent on long tern Government Bonds

(gilt edged) securities + (Market Risk premium) x Beta Variant for the Company.

Here Beta is a relative measure of risk associated with the Company’s stock as

against the market as a whole.

Hence, WACC = kd
(b) + ke
. (S'

Where, B = Amount of debt capital^.

Page 141 of 163
 S = Amount of Equity Capital

V = Value of firm = B+S

What does EVA show?

EVA is the residual income after charging the company for the cost of capital

provided by lenders and shareholders. It represents the VALUE added to the

shareholders wealth, by generating operating profits in excess of the cost of capital

employed in the business

TABLE- If EVA ofHLL and INFOSYS

Year EVA of GROWTH of EVA of GROWTH of INFOSYS

1992 41 --- NA —

1993 60 46.34% NA —

1994 107 78.33% NA —

1995 126 17.76% NA —

1996 272 115.87% NA —

1997 365 34.19% NA —

1998 548 50.14% 71 —

1999 694 26.64% 129 81.69%

2000 858 23.63% 389 201.55%
2001 1080 25.87% 510 31.11%
Source : Annual Reports ofHLL and Infosys

The EVA of a company will increase when :

• Operating profits can be made to grow without employing more capital i.e greater
efficiency
• Additional Capital is invested in projects that return more than the cost of
obtaining new capital i.e profitable growth
• Capital is curtailed in activities that do not cover the cost of capital i.e liquidate
unproductive capital.

Page 142 of 163

The graphs given below depict the EVA growth of two of the leading companies in

the Indian Capital Market.

Rising EVA - Infosys

700 -
600 - 510 538

11
500 -
389
400 -
300
200
100
0
-
-
-
-
71

1999 2000
Source : Annual Reports oflnfosys
1
2001 2002 2003

EVA Growth - HLL

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

As is evident from the graph, in case of HLL the EVA has grown on a consistent

basis

from Rs 41 crores in the year 1992 to Rs 1080 crores in the year 2001 representing an

average growth of about 253% over this period of 10 years. This shows that there has

been a marked improvement over the last decade on the EVA front.
Page 143 of 163
This is well reflected by the increase in the value of shareholders wealth due to the

increased dividend, bonuses as well as the marked rise in the market capitalisation

seen over the years.

In case of Infosys also, the EVA growth has been spectacular by rising from just Rs71

crores in 1999 to Rs 538 crores in 2003, averaging a growth of about 164% over this

four year span.

Both the companies have fared very well in terms of the rise in the market

capitalisation, which is also illustrated by the MVA graph subsequently of Infosys.

The rising EVA of both these companies has increased shareholders wealth by way of

sustained rise in the Market Capitalisation over the years.

The shareholders have also gained by way of liberal bonuses and dividends declared

due to the rising profitability of these companies.

Market Value Added (MVA)

The enterprise value of any company is measured by the market value of its equity

and debt and is deducted by the Cash equivalents held by it.

The Market Value added of a company shows the total enterpise value of the

company. In other words, it is the summation of market capitalisation of the equity

and debt of the company and is reduced by the value of cash held by it.

Page 144 of 163

 related to the state of the Capital Markets.

The graph shows the MVA of Infosys rising dramatically from Rs 9256 crores in

1999 to Rs 58829 crores in 2000. This has been due to the unprecedented boom in the

valuation of IT companies. It then subsequently came down to Rs 26348 crores in

year 2001 and has remained more or less stagnant at that level. This is due to the fact

that the price levels of the shares of Infosys has remained static for the last about 3

years.

6.7 Relationship illustrating the linkage between Capital Market & various
Economic Barometers

There exists a relationship between market capitalization and various Economic

parameters. The following tables, graphs and analyses depict these relationships in

details.
TABLE- 15 : Relationship between Market Capitalisation and Gross Fiscal Deficit
of the Central Government
Market Capitalisation of BSE Gross Fiscal Deficit (GFD) GFD as a % of
(MC) (Rs in Bln) (Rs in Bln) MC (%)
FY96 5265 602 11.43%
FY97 4639 667 14.38%
FY98 5603 889 15.87%
FY99 5429 1133 20.87%
FY 00 9128 1047 11.47%
FY 01 6255 1188 18.99%
FY 02 6122 1317 21.51%
Source : CMIE Monthly Review of Indian Economy, November 2002 issue

Relationship between Market Capitalisation and Gross

Fiscal Deficit
10000

FY96 FY97 FY98 FY99 FY00 FY01 FY 02

ilMarket Capitalisation ofBSE(Rs in Bln) ■ Gross Fiscal Deficit (Rs in Bln)

-Linear (Gross Fiscal Deficit ( Rs in Bln)) -Linear (Market Capitalisation of BSE (Rs in Bln))

Relationship between Market Capitalisation & Gross Fiscal Deficit:

The above graph illustrates the relationship between Market Capitalisation and Gross
Fiscal Deficit.

Market Capitalisation means the Value of the Equities listed on the Stock Exchanges.
The higher the Market Capitalisation, the higher is the market levels and vice
versa.,but we are also getting a linear rising trend between market capitalization and
fiscal deficit
TABLE- UkRelationship between FII investments and Market Capitalisation of BSE
FII Investments Market Capitalisation of BSE
(Rs in Bln) (Rs in Bln)
FY96 6942 5265
FY97 8575 4639
FY98 5957 5603
FY99 -1585 5429
FY00 10122 9128
FY 01 9934 6255
FY 02 8755 6122
Source : CM1E Monthly Review of Indian Economy, November 2002 issue;
Indian Securities Market Volume V 2002, published NSE

Relationship between Market Capitalisation and FII Inflows

12000

I....... .FII Investments (Rs in Bln) IMarket Capitalisation ofBSE(Rs in Bln)

...... Linear (FII Investments (Rs in Bln)) •Linear (Market Capitalisation ofBSE(Rs in Bln))

Page 147 of 163

 Relationship between Market Capitalisation & FII Inflow :
The above graph illustrates the relationship between Market Capitalisation and
FEE Inflows. In FY 2000, Market Capitalisation and FEE Inflow grew by 73.37%
and 45.81% over FY1996 figures respectively. In FY 2002, the same grew by
16.28% and 26.12% over FY 1196 thereby showing growth along a paraUel
trend.

By FTI, we mean Foreign Institutional Investors. FEE investments are a very important
barometer for the economic development of the country’s economy.

It indicates the confidence the International Investors have on the strength of the
economy. The higher the FEE inflows, the greater is the conviction of the international
community on the economic development.

In India, it has been seen that this important barometer of economic development is
invariably intricately linked to the Market Capitalization. There are various FEEs
operating in the country like Morgan Stanley, Merill Lynch, Janus, Capital
International, Goldman Sachs etc. These are all very big investors in the world
market and it is seen from the data projected over the years that FII inflows is greatly
linked to the Market Capitalization in a direct manner which is illustrated.

So for the economic development of the economy, FII inflows are imperative and
this is again linked to the state and growth of the Capital market of the country.

TABLE-17; Relationship between Market Capitalisation and GNP

Market Capitalisation of BSE (Rs in Bln) GNP at current Market Prices (Rs in Bln)
FY 95 4334 9997
FY96 5265 11745
FY97 4639 13551
FY98 5603 15092
FY99 5429 17261
FY00 9128 19142
Source: CMIE Monthly Review of Indian Economy, November 2002 issue
TABLE-18 : Relationship between Market Capitalisation & Foreign Exchange
Reserves
Market Capitalisation of BSE Foreign Exchange Reserves
(Rs in Bln) ($Mln )
FY 95 4334 20809
FY96 5265 17044
FY97 4639 22367
FY98 5603 25975
FY99 5429 29522
FY 00 9128 35058
Source : CMIE Monthly Review of Indian Economy, November 2002 issue

Relationship between of Market Capitalisation & Foreign

Exchange Reserves
40000

35000

30000

25000 i
20000

15000

10000

5000

0
FY95 FY96 FY97 FY98 FY99 FY00

3Market Capitalisation of BSE( Rs in Bln) IForeign Exchange Reserves ($Mln )

- linear (Market Capitalisation of BSE (Rs in Bln)) -Linear(Foreign Exchange Reserves ( $Mln ))

Page 150 of 163

Relationship between Market Capitalisation & Foreign Exchange Reserves :
The above graph clearly indicates the relationship between Market
Capitalisation and Foreign Exchange Reserves. Between FY 1996 and FY 2000,
Market Capitalisation and Foreign Exchange Reserves grew by 110.61% and
68.48% respectively. In FY 2002, the same grew by 16.28% and 26.12% over
FY 1196 thereby showing a directly proportional growth.

Foreign Exchange Reserves is one of the very important barometers for measuring
the economic development of the country. It is an indication of the export
competitiveness that the country has in terms of quality and pricing. This export
comprises both of goods and services.

For example, the software sector has been one the major contributors to the FE
reserve in the recent past.. The textile sector also contributes to this reserves in a
major way, along with Direct Foreign investments. Higher FE is an indictor of higher
export led growth, which is surely a very important economic barometer.

The higher the FE, the greater is the currency stability, which is a extremely
important to the economic development of any country. The recent rise in the value
of the Rupee, bears testimony to the fact that a rising FE helps in strengthening the
currency, which is the key to any economy.

The increasing FE also helps the country in having enough reserves to meet the
import bills, especially the fuel bill, in case of emergencies also.

As is seen from the graph, that Market Capitalization has got a direct relationship
on the Foreign Exchange Reserves.

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TABLE-^Relationship between Market Capitalisation & Primary Market
Mobilisation

Market Capitalisation of BSE Primary Market Mobilisation

(Rs in Billion) (Rs in Billion)
FY96 5265 834
FY97 4639 798
FY98 5603 1095
FY99 5429 1662
FY00 9128 1857
FY01 6255 2068
FY 02 6122 2269
Source : Indian Securities Market Volume V2002, published NSE

Relationship between Market Capitalisation & Funds

10000
Mobilisation
9000

8000

7000

6000

5000

4000

3000
III JIL--.- - -I^b
■ ■■111
2000

1000

0
FY96 FY97 FY98 FY99 FY00 FY01 FY 02

E] Market Capitalisation of BSE (Rs in Bln) ■ Primary Market Mobilisation (Rs in Bln)

—linear (Primary Market Mobilisation (Rs in Bln)) •linear (Market Capitalisation ofBSE(Rs in Bln))
 Relationship between Market Capitalisation & Funds Mobilisation :
The above graph illustrates the relationship between Market Capitalisation and Funds
mobilisation. In FY 2000, Market Capitalisation and FII Inflow grew by 73.37% and
45.81% over FY1996 figures respectively. The data illustrates that between FY 1996
and FY 2002, Market Capitalisation and Funds mobilization grew by 16.28%
and 172.1% showing a directly proportional growth.

State Fund mobilization is very important from the economic development view, as
the funds goes towards the funding of the industrial projects. The funds helps in
improving the technology, reducing the cost of funds and ultimately improves the
industrial production. It increase the distributable surpluses, improves the liquidity in
the economy. It makes the industry cost competitive, increase profits which again
goes towards economic development.

Therefore the mobilized funds contribute towards higher market capitalization.

Therefore as is clearly seen from the graph, that Market Capitalization has a direct
relationship on the FE.

TABLE- 20; Relationship between Deposit & Credit Growth

SCB ' s Deposits % Change SCB ' s Credit % Change

FY 95 21.1 27.2
FY96 12.1 20.1
FY 97 16.5 9.6
FY 98 18.4 16.4
FY 99 19.3 13.8
FY00 19.3 23.1
FY 01 16.2 16.6
FY 02 11.5 11.4
Source : CMIE Monthly Review of Indian Economy, November 2002 issue
Relation between Deposit & Credit Growth
The above graph depicts the relationship between Deposit and Credit Growth
between FY 1996 and FY 2002.

The deposit rate and credit growth has a direct relationship and shows a direct co­
relation. Credit growth is essential for the growth of industries and provides the impetus
to the economy in terms of providing cheap and easy availability of capital. This helps
industrial production and growth and leads to economic growth and revival.

The credit growth is dependent on the deposit growth and a higher credit deposit ratio is
a health sign for economic development.

A higher deposit growth is a sign of greater wealth creation and savings and investment
of the country.

As the graph illustrates, the two are interlinked and follows a direct pattern over a
period of time.

Page 154 of 163

TABLE-21 : Relation between Industrial Growth and Credit Growth

Index of Industrial Production (% Change) SCB ' s Credit (% Change)

FY 95 9.1 27.2
FY96 13.1 20.1
FY 97 6.1 9.6
FY 98 6.6 16.4
FY 99 4.1 13.8
FY00 6.6 23.1
FY 01 5.1 16.6
Source : CMIE Monthly Review of Indian Economy, November 2002 issue

Relation between Industrial Growth and Credit Growth

♦— Index of Industrial Production % Change —■—SCB' s Credit % Change

------ linear (SCB' s Credit % Change) —1 —linear (Index of Industrial Production % Change)

Relation between Industrial Growth & Credit Growth

The above graph depicts the relationship between Industrial Growth & Credit
Growth between FY 1995 and FY 2001.

Page 155 of 163

TABLE- 22; Relationship between Market Capitalisation and Industrial Growth

Index of Industrial Production Market Capitalisation of BSE

(% Change) (Rs in Billion)
FY 95 9.1 4334
FY96 13.1 5265
FY97 6.1 4639
FY98 6.6 5603
FY99 4.1 5429
FY00 6.6 9128
Source : CMIE Monthly Review of Indian Economy, November 2002 issue

Relation between Industrial Growth & Market Capitalisation

The above graph depicts the relationship between Industrial Growth & Market
Capitalisation between FY 1995 and FY 2000.

Page 156 of 163

 So it goes to prove beyond doubt that Capital market and Economic barometers are

closely intricately linked over a sustained period of time.

6.8 Conclusion

The stock market and the economy are closely inter- related to a great extent. In the

modern day in any developed economy, stock market plays exceedingly important

role in the economic development and growth.

This has been demonstrated by the fact that in the Indian context also, we have

witnessed that how various segments of the economy i.e. household, corporate and

the Government sector depends heavily on the capital market for various reasons such

as fund raising, channeling of the funds as well as wealth creation. The industrial

growth is closely dependent on the availability of cheap funds, which the Capital

market provides. This in turn provides the impetus for increased industrial growth,

increased production, lowering costs. All these improves the financial performance of

the companies, which in turns translates to better and improved performance and

prospects.

The shareholders also gains from the rising Capitalisation and his wealth increases

manifold in a relatively short time. The shareholder also gains by means of rising

EVA (Economic Value Added) and MVA (Market Value Added) of the corporate.

The rising market Capitalisation adds to the growth of the economy and increases the

consumption of the average consumer. This in turn fuels a demand led growth in the

whole economy.
As it has been well illustrated in the chapter, there is a very strong and direct linkage

between the economic barometers like Foreign Exchange Reserves, GNP growth,

GDP growth, Foreign Funds inflows, Capital raising activities and the Market

Capitalisation.

REFERENCES

• Indian Securities Market - A Review Volume V, 02, published by NSE

• Monthly Review of the Indian Economy published CMIE

• RBI Bulletins

• BSE Site

• NSE Site

• India’s Economy in the 21st Century by Raj Kapila and Uma Kapila

• The Economic Times

• Journal of Institute of Chartered Accountants of India

• Financial Management: Theory & Practice by Prasanna Chandra

• Financial Management: Test & Problems by N. Y Khan & P.K Jain

• Annual Reports of HLL

• Annual Reports of Infosys

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