Before discussing the equities market, we should first understand the basic meaning of markets, their functions and classification.
What is a Market?
A market is a location where buyers and sellers come into contact to exchange goods or services. markets can exist in various forms depending
Can Markets Exist in Different Forms?
Yes, the markets do exist in different forms depending on the nature of location and mode of contact. It can have a physical location where buyers and sellers come in direct contact with each other or a virtual location where the buyers and sellers contact each other employing advance means of communication. There is another form of market where actual buyers and sellers achieve their objectives through intermediaries.
Securities Markets in India : An Overview
The process of economic reforms and liberalisation was set in motion in the mid-eighties and its pace was accelerated in 1991 when the economy suffered severely from a precariously low foreign exchange reserve, burgeoning imbalance on the external account, declining industrial production, galloping inflation and a rising fiscal deficit. The economic reforms, being an integrated process, included deregulation of industry, liberalisation in foreign investment, regime, restructuring and liberalisation of trade, exchange rate, and tax policies, partial disinvestments of government holding in public sector companies and financial sector reforms. The reforms in the real sectors such as trade, industry and fiscal policy were initiated first in order to create the necessary macroeconomic stability for launching financial sector reforms, which sought to improve the functioning of banking and financial institutions (FIs) and strengthen money and capital markets including securities market. The securities market reforms specifically included:
- Repeal of the Capital Issues (Control) Act, 1947 through which Government used to expropriate seignoirage and allocate resources from capital market for favoured uses;
- Enactment of the Securities and Exchange Board of India Act, 1992 to provide for the establishment of the Securities and Exchange Board of India (SEBI) to regulate and promote development of securities market;
- Setting up of NSE in 1993, passing of the Depositories Act, 1996 to provide for the maintenance and transfer of ownership of securities in book entry form
- Amendments to the Securities Contracts (Regulation) Act, 1956 (SCRA) in 1999 to provide for the introduction of futures and option.
- Other measures included free pricing of securities, investor protection measures, use of information technology, dematerialisation of securities, improvement in trading practices, evolution of an efficient and transparent regulatory framework, emergence of several innovative financial products and services and specialised FIs etc. These reforms are aimed at creating efficient and competitive securities market subject to effective regulation by SEBI which would ensure investor protection.
The corporate securities market in India dates back to the 18t century when the securities of the East India Company were traded in Mumbai and Kolkotta. The brokers used to gather under a Banyan tree in Mumbai and under a neem tree in Kolkotta for the purpose. However the real beginning came in the 1850’s with the introduction of joint stock companies with limited liability. The 1860’s witnessed feverish dealings in securities and reckless speculation. This brought brokers in Bombay together in July 1875 to form the first formally organised stock exchange in the country viz. The Stock Exchange, Mumbai. Ahmedabad stock exchange in 1894 and 22 others followed this in the 20th century. The process of reforms has led to a pace of growth almost unparalleled in the history of any country. Securities market in India has grown exponentially as measured in terms of amount raised from the market, number of stock exchanges and other intermediaries, the number of listed stocks, market capitalisation, trading volumes and turnover on stock exchanges, investor population and price indices. Along with this, the profiles of the investors, issuers and intermediaries have changed significantly. The market has witnessed fundamental institutional changes resulting in drastic reduction in transaction costs and significant improvements in efficiency, transparency and safety, thanks to the National Stock Exchange. Indian market is now comparable to many developed markets in terms of a number of parameters. There are very few countries who have higher turnover ratio than India. Market capitalisation as a percentage of GNP compares favourably even with advanced countries and much better than emerging markets. In terms of number of companies listed on stock exchanges, India is second to none. At the end of 1998, the International Finance Corporation (IFC) ranked India as the 21st in terms of market capitalisation, and 19th in terms of total value traded in stock exchanges. 142 Indian stocks, which accounted for 66.4% of market capitalization and 74.1% of total value traded, had a 5.78% weight in IFC Global Composite Index of emerging market stocks. In the case of the IFC investable Composite Indices, which include emerging market stocks that are determined by the IFC to be legally and practically available to foreign portfolio investors, India’s share was only 2.31%. India has also the distinction of having the second largest investor population in the world. According to a study by the Society for Capital Market Research and Development (Investor Disenchantment with Equities by L. C. Gupta, Indian Financial Markets & Institutions, October 1999), estimated investor population in India is stagnating at 20 million since 1995. These figures indicate the tremendous potential for growth of Indian securities market.
Structure and Size of the Markets
Today India has two national exchanges, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Each has fully electronic trading platforms with around 9400 participating broking outfits. Foreign brokers account for 29 of these. There are some 9600 companies listed on the respective exchanges with a combined market capitalisation near $125.5bn. Any market that has experienced this sort of growth has an equally substantial demand for highly efficient settlement procedures. In India 99.9% of the trades, according to the National Securities Depository, are settled in dematerialized form in a T+2 rolling settlement The capital market is one environment. In addition, trades are guaranteed by the National learning Corporation of India Ltd (NSCCL) and Bank of India Shareholding Ltd (BOISL), Clearing Corporation houses of NSE and BSE respectively. The main functions of the Clearing Corporation are to work out (a) what counter parties owe and (b) what counter parties are due to receive on the settlement date. Furthermore, each exchange has a Settlement Guarantee Fund to meet with any unpredictable situation and a negligible trade failure of 0.003%. The Clearing Corporation of the exchanges assumes the counter-party risk of each member and guarantees settlement through a fine-tuned risk management system and an innovative method of online position monitoring. It also ensures the financial settlement of trades on the appointed day and time irrespective of default by members to deliver the required funds and/or securities with the help of a settlement guarantee fund.
Style of Operating
Indian stock markets operated in the age-old conventional style of fact-to-face trading with bids and offers being made by open outcry. At the Bombay Stock Exchange, about 3,000 persons would mill around in the trading ring during the trading period of two hours from 12.00 noon to 2.00 p.m. Indian stock markets basically quote-driven markets with the jobbers standing at specific locations in the trading ring called trading posts and announcing continuously the two-way quotes for the scrips traded at the post. As there is no prohibition on a jobber acting as a broker and vice versa, any member is free to do jobbing on any day. In actual practice, however, a class of jobbers has emerged who generally confine their activities to jobbing only. As there are no serious regulations governing the activities of jobbers, the jobbing system is beset with a number of problems like wide spreads between bid and offer;particularly in thinly traded securities, lack of depth, total absence of jobbers in a large number of securities, etc. In highly volatile scrips, however, the spread is by far the narrowest in the world being just about - 0.1 to 0.25 per cent as compared to about 1.25 per cent in respect of alpha stocks, i.e. the most highly liquid stocks, at the International Stock Exchange of London. The spreads widen as liquidity decreases, being as much as 25 to 30 per cent or even more while the average touch of gamma stocks, i.e. the least liquid stocks at the International Stock Exchange, London, is just about 6 to 7 per cent. This is basically because of the high velocity of transactions in the active scrips. In fact, shares in the specified group account for over 75 per cent of trading in the Indian stock markets while over 25 per cent of the securities do not get traded at all in any year. Yet, it is significant to note that out of about 6,000 securities listed on the Bombay Stock Exchange, about 1,200 securities get traded on any given trading day.
The question of automating trading has always been under the active consideration of the Bombay Stock Exchange for quite sometime. It has decided to have trading in all the non-specified stocks numbering about 4,100 totally on the computer on aquote-driven basis with the jobbers, both registered and roving, continuously keying in their bids and offers into the computer with the market orders getting automatically executed at the touch and the limit orders getting executed at exactly the rate specified. In March 1995, the BSE started the computerised trading system, called BOLT - BSE on-line trading system. Initially only 818 scripts were covered under BOLT. In July 1995, all scripts (more than 5,000) were brought under the computerized trading system. The advantages realised are:
- improved rading volume;
- reduced spread between the buy-sell orders
- better trading in odd lot shares, rights issues etc.
Equities In India: The Dismal Decade
Lets review the performance of equities in India from past ten years. Equities in India did provide attractive returns from 1979- 91 however; they fared poorly in the decade of 1991-2001. If we see the compounded annual returns generated by Sensex, the most widely followed equity index in India, at the end of 2001 were as follows for various investment periods:
Thus, we can see that equities have under performed even bank deposits for each of the periods considered above.
What is the Picture of Key Economic Numbers?
During the decade of 1991-2001, the nominal GDP of the country increased by about 3.7 times, forex reserves soared from a near zero level to a record of US $ 48 billion, exports multiplies by 2.4 times, the prime lending rate fell from around 19% to 11.5%, and the earnings of Sensex stocks grew at a compound rate of 13.3%. It seems surprising that the growth of the economy and corporate earnings has not been reflected in equity returns. What could have caused this discrepancy? The factors that have contributed to this appear to be as follows:
- The market was very bullish at the beginning of the decade of 1991-2001, but extremely bearish at the end of the decade.
- During the decade of 1991-2001, the maximum growth occurred in the services sector (which now accounts for nearly 50% of the GDP), whereas the services sector accounts for less than the quarter of Sensex.
- The excessive volatility of the Indian stock market has perhaps driven away long-term investors who can contribute to grater rationality in price movement.
- The periodic scams that occurred during this period have shaken investors confidence.
Two major reasons why Indian securities are now increasingly regarded as attractive to international investors are the relatively high returns compared with more developed global markets as well as the low correlation with world markets.