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Securities Markets

Equity market
Pre IPO stage 4.3 In addition to the traditional sources of capital from family and friends, startup firms are created and nurtured by Venture Capital Funds and Private Equity Funds. According to the Indian Venture Capital Association Yearbook (2003), investments of $881 million were injected into 80 companies in 2002, and investments of $470 million were injected into 56 companies in 2003. The firms which received these investments were drawn from a wide range of industries, including finance, consumer goods and health. 4.4 The growth of the venture capital and private equity mechanisms in India is critically linked to their track record for successful exits (Table 4.1). Investments by these funds only commenced in recent years, and we are seeing a rapid buildup in a full range of channels for exit, with a mix of profitable and unprofitable outcomes. This success with exit suggests that investors will allocate increased resources to venture funds and private equity funds operating in India, who will (in turn) be able to fund the creation of new firms.

The primary market 4.5 The volume of public issues rose by roughly five times to a level of Rs.35,859 crore in 2004 (Table 4.2). Beyond this, a considerable volume of issuance also takes place through private placements. The bulk of

Table 4.1 : Types of exit for venture capital or private equity funds Category IPO Post-IPO Trade sale Bankruptcy M&A Buyback 2001 0 1 4 1 4 8 2002 0 7 6 0 7 16 2003 2 40 8 0 6 16

Source: Indian Venture Capital Association Yearbook, 2003.

this was made up of equity issuance, which amounted to Rs.33,475 crore in 2004. This was the highest-ever level of public equity

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The success of these large issues has dispelled earlier doubts about the feasibility of billion-dollar offerings in the Indian market. In this process.2 : Primary market (Rs.7 A major development in the Indian primary market has been the introduction of “screen based bookbuilding”. where securities are auctioned through an anonymous screenbased system.643 48 issuance in India’s history. 64 per cent in 2003 and 99 per cent in 2004. crore) Calendar year 2001 Debt 4. giving a stable price to earnings (P/E) ratio. and the bulk of primary issuance of debt securities took place through private placement. and the price at which securities are sold is discovered on the screen.475 1.4.6 The growing sophistication of the market was visible in a slew of very large issues. 4. The secondary market 4. it is reported that resource mobilisation through bookbuilding rose steadily from 25 per cent of public equity offerings in 2001 to 53 per cent in 2002. is the size of securities exchanges.916 Equity 726 Of which.8 Early indications suggest that a considerable volume of issuance may take place through the public equity issues market in 2005 also.825 28 2003 2004 3. IPOs 525 Number of IPOs 17 Mean IPO size 31 Total Number Source: SEBI. and BSE moved up from 8th rank in 2001 to 5th rank in 2003 (Table 4. The public debt market continued to languish at low levels.870 crore in 2004. 4.981 6 330 4. In 2002.6).nic.682 35. This eliminates the delays. It is reported that fresh issuance of securitisation paper grew sharply over this period. over two times higher than the previous peak of 1995. The mean IPO size rose from Rs. Economic Survey 2004-2005 .373 1.9 One international ranking in the area of finance. this value continued to be much behind those found in developed countries. the rise in market value was roughly proportional to the rise in corporate earnings. 4.790 2.383 2.3). Table 4.14.451 2. risks and implementation difficulties associated with traditional procedures.892 33.694 crore in 2004. While the average value of transaction in India is small by world standards. 76 website : http:/indiabudget. to a level of Rs.Table 4. 2002 3.10 While index returns were strong in the recent period (Tables 4. both in absolute terms and when viewed in comparison against the overall debt market.31 crore in 2001 to Rs.3 : Biggest exchanges by number of transactions in 2004 Rank by number of transactions 2001 NASDAQ NYSE NSE Shanghai BSE Korea Taiwan Shenzhen Deutsche Borse London 1 2 4 3 8 6 7 5 9 14 2002 1 2 3 5 7 4 6 8 9 12 2003 1 2 3 4 5 7 6 8 9 11 2004 1 2 3 4 5 6 7 8 9 10 5. However. which are required to be implemented by commensurately large and yet low-cost IT systems. as measured by the number of transactions. NSE displaced Shanghai to take 3rd place.5 and 4. where India figures.611 13 26 149 870 6. NSE and BSE were stable at rank 3 and 5 respectively in 2003 and 2004. Despite considerable skepticism about the extent to which computers could replace the services of highly skilled investment bankers.940 22. India has a very large number of transactions.859 42 65 4. the primary market has matched the secondary market in terms of using technology to achieve an impersonal system of price discovery with widespread retail participation that spans the country.

5 2.85.0 1.Table 4.73 10.444 crore in 2004. reflecting the flow of news in these two years.9.07 2002 2003 2004 Securities markets website : http:/indiabudget.248 1.cap.015 1.2.65. Index volatility in 2004 was elevated to 2001 levels.668 1.9 per cent in 2003 were followed by modest returns of 10.7 per cent in 2004.1 7. Strong returns of 71.86 13.9 6.12 The second tier of 50 liquid but smaller stocks makes up the Nifty Junior index.007 crore in 2001 to Rs.52.93 5.831 crore in 2004.02. Table 4.nic.2 2.35.84 8. The volatility of this index is somewhat higher than that of Nifty.409 1.02.7 9. This index has also seen a sharp rise in market capitalisation.85.498 crore in 2001 to Rs.62 15.6 : Equity returns.26 141.10 14.37 15.23 20. 4.11 The Nifty index.28.3 3. Daily Volatility End-year P/E Nifty Junior : Returns (per cent) End-year mkt.8 1.8 35. Daily Volatility End-year P/E -46. both in the upward and the downward direction. from Rs.64 72.831 1.32 -17.07 14.35.59 17.4 : Movements of the index of the top 50 stocks (Nifty) 2001 January February March April May June July August September October November December 1372 1351 1148 1125 1168 1108 1073 1054 914 972 1067 1059 2002 1075 1142 1130 1085 1029 1058 959 1011 963 951 1050 1094 2003 1042 1063 978 934 1007 1134 1186 1357 1417 1556 1615 1880 2004 1810 1800 1772 1796 1484 1506 1632 1632 1746 1787 1959 2081 Table 4.916 1. volatility.528 1. This may reflect a percolation of liquidity and market efficiency from the top 50 stocks to a second tier of mid-cap stocks. The gap in P/E.444 1.83 71.5 : Movements of the index of the next 50 stocks (Nifty Junior) 2001 January February March April May June July August September October November December 2408 2141 1602 1525 1627 1415 1343 1277 1084 1174 1334 1298 2002 1349 1496 1567 1608 1497 1617 1456 1453 1258 1255 1337 1413 2003 1377 1387 1260 1340 1664 1784 2012 2275 2457 2656 2801 3406 2004 3368 3331 3392 3640 2847 2903 3082 3199 3504 3482 3885 4453 4.35 3. which shows the biggest 50 liquid stocks in the country.007 1.73 30. between Nifty and Nifty Junior.34. experienced a sharp growth in market capitalisation from Rs.498 1.5 28.17 18.943 1.9 6.46.1. market capitalisation and Price Earnings (P/E) ratio 2001 BSE Sensex: Returns (per cent) End-year mkt.230 1.94 14.19 77 . thus giving the benefit of a low cost of capital for a wider set of firms.76. has been substantially closed in the period from 2001 to 2004.9 2. Daily Volatility End-year P/E Nifty : Returns (per cent) End-year mkt.73 15.71 15.57 3.cap.cap.32. Returns on this set of stocks appears to have a high sensitivity to returns on Nifty.34 12.65.

805 3.7 : Volatility of weekly returns on the equity market Period Class of stocks India Top 50 (Nifty) Next 50 (Nifty Junior) Outside India U.has also obtained major progress on liquidity.Nifty Junior .7).8).have significantly helped market liquidity.303 3. Table 4. With a turnover ratio of 107 per cent.14 A liquid market is one where transacting is frictionless.399 3.31 225 0.S. 4. from 0. This group of stocks has benefited from the move to rolling settlement. 4. However.13 Equity volatility in India and abroad has been lower in the latest two years as compared with the recent decade (Table 4. 78 website : http:/indiabudget.which were the two major changes of this period .27 164 0.31 per cent over this period.12 131 0.5 million (per cent) 565 0. a particularly sharp decline has come about in the volatility of Nifty Junior. the gap between Nifty and Nifty junior in liquidity actually worsened between 2001 and Economic Survey 2004-2005 . (S&P 500) Korea (Kospi) 2. However. 5 million (per cent) Nifty Junior: Turnover ratio (per cent) NSE impact cost at Rs.10/2004. In India.2. the Indian equity market has been much more volatile than that of the United States.538 4. hence the best measure of liquidity is the “impact cost” suffered when doing transactions on the market.551 Oct ’95 Dec ’04 Jan ’03 Dec ’04 the shift to rolling settlement.987 1.010 3.455 4.16 India is ranked 12th in an international comparison of turnover ratio (one year’s trading volume divided by market capitalisation) on the equity spot market.0. While liquidity of Nifty junior improved in absolute terms. and the takeoff of derivatives trading . this group of stocks has not had the direct benefits of derivatives trading on individual stocks.62 per cent to 0. in the 12-month period from November 2003 to October 2004 (Table 4.10 133 0. Indian equity index volatility is not unlike that of Korea in the recent period.15 The second tier of stocks .41 101 0. High liquidity corresponds to low impact cost.62 369 0. The time-period from October 1995 onwards is homogeneous insofar as India had fully moved to anonymous electronic exchangetraded markets over this period. and indirectly from access to index derivatives trading.9).27 per cent in 2001 to 0.8: Equity spot market liquidity For calendar year 2001 Nifty: Turnover ratio (per cent) NSE impact cost at Rs.4. India’s situation appears to be broadly in the range of values seen with well Table 4.09 2002 2003 2004 11 12 13 14 15 Note : Pertains to 11/2003 .nic. This suggests that Table 4. The impact cost for doing trades to buy or sell Rs. India lags behind China and Turkey.9 : Turnover ratio (per cent) on the equity spot market: An international comparison Rank 1 2 3 4 5 6 7 8 9 10 Country United Kingdom Taiwan Turkey China Germany Spain United States Sweden Korea Italy Finland India Thailand Switzerland Japan Turnover ratio 165 163 141 139 125 120 119 118 118 113 112 107 98 91 88 4. with impact cost going down from 0.32 89 0.09 in 2004 (Table 4.5 crore of Nifty has dropped steadily and dramatically over this period.

19 The average trade size on the NSE and BSE spot markets in 2004 was Rs.882 4. which is the best measure of the number of participants in the market.75.1 crore.12. given that this trade size requires collateral of roughly Rs.098 2002 3. This is in sharp contrast with (say) the bond market.75.57. and improvements in regulation.782 4.322 3.336 2003 4.14. turnover on the NSE equity spot market grew by 69 per cent (Table 4.735 2002 6.developed equity markets such as those of Japan (88 per cent) or the United States (119 per cent).32.658.814 3.201 39.076 12.322 Table 4. The number of accounts at NSDL.24.485 3.10).23.103 27.20 The average trade size at the NSE derivatives segment rose significantly from 2001 to 2004. 4.00.612. where the average trade size exceeds Rs.509 35. with turnover growing dramatically to reach a level which was 2.03. had stagnated in 2001 and 2002 at roughly 3. in response to growing knowledge in the country.095 Securities markets website : http:/indiabudget.884 2004 5.1 lakh.610 4.142 9. Over this same period. There is considerable headroom for growth. the equity derivatives market in India has yet to attain the multiples of spot market turnover which are prevalent in successful derivatives exchanges internationally.253 25.27.7 to 3.09. At the same time. Investors 4.remained accessible to a large number of households.783 2.984 respectively.334 26. to reach roughly 6 million as of end-2004.85.18 There is growing evidence about increasing participation in the securities markets.88.2 times bigger than equity spot trading at NSE. crore) For calendar year 2001 NSE spot BSE spot NSE derivatives BSE derivatives Indian equity turnover 6.86. This suggests that in the future.11). However. 4.17 Between 2001 and 2004. The evidence for 2004 corresponds to 5.5 lakh .984 4.95.45. 4.07. If institutional investors (domestic or foreign) had been major players in this market.738 19.443 928 13. the value as of 2004 of roughly Rs.848 2. the average trade size would have been much bigger.969.33.703 22.508 2003 9. Spot market turnover is likely to grow in rough proportion to the growth in market capitalisation.983 26.173 43. This grew by 21 per cent and then 29 per cent in the following two years.25.790 3. Table 79 .287 2004 11.077 27.31.10 : Growth of turnover (Turnover in Rs.715 and Rs.159 5.8 million (Table 4.nic.993 22.400 new depository accounts being opened per weekday. the headroom for growth in spot market turnover in India will come from growth of the economy and of market capitalisation. The domination of individual investors in the derivatives market is even more complete than that found on the spot market. This highlights the domination of individual investors in price discovery. the NSE equity derivatives market came of age.11 : A predominantly retail market As of year-end 2001 Number of NSDL accounts Average trade size (rupees): NSE spot BSE spot NSE derivatives 40.715 23.161 14.

of the 637 registered FIIs and 1.23 Over the past four years. FIIs purchased Rs. 4.76.779 38.551 5. This reflects the diverse range of FIIs.876 47. compared with overall market size. 2002 490* 1.458 2004 637 1.759 25. 4. crore) For calendar year 2001 End-year number of FIIs End-year number of sub-accounts Spot market activity: Gross buy Gross sell Net Derivatives activity: Gross buy Gross sell Net Note : Data on derivatives transactions by FIIs were not separately reported prior to 2004.13 : Foreign institutional investors (Rs.424 6.316 77. 80 website : http:/indiabudget.740 1. are consistent with the picture of India being a highly retail market.965 84. in 2004.917 71.3 per cent of derivatives turnover (Table 4. 4.600 1.2. pool of foreign investors.372* 2004 came from FIIs. These small magnitudes.938 4.12).877 crore and sold Rs.451 31.940 crore . The entry of FIIs has further strengthened the diversity of views and compulsions.205 86.472 1.785.537 securities. Since price discovery primarily takes place on the derivatives market.928 527* — 51.479 2003 32.8 per cent of spot market turnover. Growth of these two measures is desirable insofar as it indicates a more diverse. India’s equity market has always been strong in terms of attracting a diverse array of participants. On a typical day.24 Institutional investors (including most domestic and foreign) account for roughly 10.40.965 crore in 2004 (Table 4.13).785 1. assets in growth funds rose sharply in 2004 to reach Rs.537 crore (Table 4.338 crore of derivatives turnover.50. putting the spot and derivatives markets together. The bulk of mutual fund assets continue to be in debt securities. Thus.785 subaccounts.551 crore.38.32. 4.128 * As on 31st March.164 1.840 crore.801 4.469 14. with assets under management nearly stagnant at Rs.361* 94. which amounted to Rs.372 to 1. and the number of sub-accounts has risen from 1.of Economic Survey 2004-2005 .12 : Assets under management of mutual funds (Rs.14).50.412 63.70.85. However. some buy while others sell Table 4.1. and just 3.257 3.1. this suggests that individual investors and not institutional investors dominate price discovery.663 1.371 14.502 2003 502* 1. where households directly own the bulk of securities.672 The mutual fund industry has experienced slow growth in recent years. with heterogeneous views and compulsions.133 -1. and hence more stable. crore) At end of year 2002 Money market Gilt Income Growth Balanced ELSS Total 10.258 22.25 Almost all derivatives turnover by institutions .nic. who accounted for Rs. 1.2.4. with a diversity of views and portfolio strategies.22 There has been a considerable focus upon the net purchases of FIIs on the equity spot market.1.893 2004 59.651 13. the number of registered FIIs has risen from 490 to 637.707 38.447 4. and helped fuel market liquidity.093 Table 4.954 30.

016 26.470 1. To ensure comparability.645 5.14 : Gross turnover from institutional investors (Rs.appears to be a large number. This may reflect superior human resources.327 0.83 per cent of the overall Indian equity market. as Rs.327 in calendar years 2003 and 2004 (Table 4. this transaction shows up twice.273 1.449 5.80.338 23. This should have led to higher correlations between Indian stock market indexes and those of the outside world. systems.226 0.28. Table 4. the monsoon affects both India and Bangladesh).11.848 6. foreign investors require higher expected returns from Indian equities when global interest rates are higher).745 1.5. While Rs.820 3.34. trade integration (e.g.288 0.g. 4. S&P 500 of 0. it now makes up 5.14.016 55.940 1.16.102 0.366 crore in 2003 to Rs.27 Derivatives transactions by FIIs were not separately tracked prior to 2004.g. Indian exports benefit from a global upswing) and portfolio integration (e.085 2.316 0.374 54.15 : Correlations of equity index (weekly) returns Period Class of stocks Oct ’95 Dec ’04 Jan ’03 Dec ’04 Correlations with S&P 500 Nifty Nifty Junior Korean KOSPI Nifty and KOSPI 0.76.26 A key feature of measurement in Table 14 is the use of “gross turnover”.07. However.13.13.02.S. India has made considerable progress in terms of greater trade integration.717 crore in 2004.58. 4.581 90.015 1.56.366 34.47.742 28. firm-level policies. the extent of global integration is still quite small.717 crore of oneway FII turnover .in 4.574 2. crore) For calendar year 2001 Spot market: NSE+BSE gross turnover All institutions FIIs Derivatives: NSE+BSE gross turnover All institutions FIIs Equity spot + derivatives NSE+BSE gross turnover All institutions FIIs 24. when data is captured about the gross trading of market participants.58. the table reexpresses all data as gross turnover.Table 4.622 1.100 when one security worth Rs.25.70. with a correlation between Nifty and the U.195 0. it appears that domestic institutions have a negligible presence on the equity derivatives market.142 1.32.509 0. shows volume of Rs.425 81 .05.100 goes from a seller to a buyer.397 52. by doubling the trading volume as reported by exchanges. as normally reported by exchanges.02.58.15). risk management systems.05.430 19.430 26. Trading volume data. and regulatory constraints operative upon FIIs relative to domestic institutions.489 51.28 Equity indexes get correlated across countries through exposure to common shocks (e.609 3.366 of trades. In the period from 1995 onwards.379 2002 2003 2004 Conversely. Securities markets website : http:/indiabudget. The inclusion of derivatives data from 2004 onwards overstates the increase in FII turnover for 2004.581 90.5.summing across spot and derivatives markets .14.92.374 54.nic.02. and entry of foreign investors.717 83. As yet. which hence shows a sharp jump from Rs.

In 2004. index derivatives have been extremely successful (Table 4. Index derivatives essentially shows the turnover for futures and options on Nifty on Economic Survey 2004-2005 . However.103 10.173 16.316.4.425. This has given a higher correlation in the most recent two years of 0.944 256 17. it is reported that index fund investment strategies can cover 64 per cent of India’s broad market capitalisation.826 3.1. 4.99 2003 14. Korea had high trade integration as of 1995.224 2.509.848 2. At the same time. Korea further liberalised portfolio flows. showing growth well in excess of the growth rates seen on either the equity spot market or the individual stock derivatives market.487 715 40. portfolio flows.750 crore. As of December 2004. on all days. and FDI.94 2002 3. Table 4. Index funds on both Nifty and Nifty junior now exist. but had many barriers to portfolio flows. assets under management with index funds have stagnated in the last four years at roughly Rs.64 2004 25. 4.32 Data for “Stock derivatives” in Table 4.30 The indexation industry.676 5.956 213 0. However. where the takeoff of derivatives trading in India largely appears to have involved trading in derivatives on individual stocks. Nifty Junior.142 9.16).195 against the S&P 500.076 21.74. This reflects growing knowledge in the market.091 9.31 While index funds have not yet taken off in India. the second tier of the next 50 less liquid stocks.86. and futures and options on the BSE Sensex on the BSE. it is interesting to note that the dominant product at BSE is the BSE Sensex as an underlying for futures and options. is an area of growth in sophistication of Indian finance.16 : Index derivatives turnover (Rs. Index derivatives were weak in 2002 and 2003. and Nifty junior was at Rs. While BSE commands little market share in derivatives trading. the market capitalisation of Nifty was Rs.99.33 Turnover in index derivatives in 2004 was roughly three times larger than that of 2003. and Nifty is now clearly the most important underlying on the market.263 3. index derivatives went up from 12 per cent of NSE derivatives turnover in 2002 to 35 per cent in 2004.277 0.738 19.903 1. which deals with financial products derived from market indexes.821 0.12. Through these.65 lakh crore. the correlation between Nifty and the Korean Kospi has risen from 0.nic. crore) For calendar year 2001 NSE derivatives BSE derivatives NSE stock derivatives BSE stock derivatives NSE index derivatives BSE index derivatives Fraction of days where Nifty was #1 underlying 38. In India.45.443 928 3. 4. Nifty was the largest single underlying on the equity derivatives market.514 17. and a shift to more sophisticated trading strategies. which suggests that India is now more integrated with the factors that affect all emerging markets such as fluctuations in world trade.29 The Korean Kospi index serves as a proxy for “other emerging markets”.9 lakh crore. has an even lower correlation of 0.16 sums up all futures and options on all individual stocks. In the period after the East Asian Crisis.31.081 1 82 website : http:/indiabudget.288 to 0.31. Financial products derived from market indexes 4.04. This gave a KoreaUS correlation of 0.