Relative Size of a few markets Turnover in Financial Markets in India 0.9 Money Market 0.8 Government Securities Market Foreign Exchange Market (Inter-bank)Average Daily Turnover (Rupees Trillion) Equity Market (cash segment) 0.7 Equity Derivatives at NSE 0.6 0.5 0.4 0.3 0.2 0.1 0 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 Years
Stock Market Performance
Stock Exchanges Exchange Market Cap Companies listed Turnover (USD mill) Total Domestic Foreign velocity NYSE Group 9,363,074.0 3,330 2,910 420 233% Tokyo SE 2,922,616.3 2,389 2,373 16 148% Nasdaq 2,203,759.6 2,919 2,586 333 1038% Euronext 1,862,930.9 1,013 1,013 0 135% London SE 1,758,157.7 3,072 2,399 673 147% Shanghai SE 1,557,161.3 864 864 0 114% Hong Kong Exchanges 1,237,999.5 1,262 1,252 10 82% TSX Group 997,997.4 3,830 3,747 83 104% Deutsche Börse 937,452.9 832 742 90 218% BME Spanish Exchanges 871,061.4 3,557 3,517 40 163% Swiss Exchange 761,896.1 323 253 70 115%12 Bombay SE 613,187.6 4,925 4,925 0 28% BM&FBOVESPA 611,695.0 393 384 9 66% Australian SE 587,602.7 2,003 1,918 85 108%15 National Stock Exchange India 572,566.8 1,405 1,405 0 74% OMX Nordic Exchange 503,725.8 821 799 22 132% Korea Exchange 470,417.3 1,796 1,792 4 196% Borsa Italiana 456,206.7 300 294 6 174% Johannesburg SE 432,422.1 410 366 44 62% Shenzhen SE 389,248.3 740 740 0 225%
Rise in listing
Stock, Debt, Currency and Derivative Markets
Most debt is privately placed
Bonds available for trading
G-Secs dominate trades
Roadblocks in the developmentof the corporate bond market TDS Stamp Duty Too many small issues Procedural complications in making public issues Lack of centralized information on bond trading, prices and defaults Lack of uniformity in market practices like lot size and conventions for coupon calculations Lack of market makers Financial institutions not allowed to hold anything below top- rated corporate security Restriction on these bonds being used as collateral for repo transactions.
Commodities Derivatives Turnover at BSE & NSE 8.4 trillionTurnover at MCX, Mar 08 3.6 trillionTurnover at MCX, June 09 5.1 trillion
Creating More Efficient and Liquid Markets
Rajan Committee Recommendations In markets that exist, apart from the equity market for large capitalization stock, the ability to trade consistently at low cost (that is, liquidity) and the tendency of market prices to reflect fundamentals (that is, market efficiency) are typically low for most markets. This needs to change for markets to play a bigger role in inclusion, growth, and stability Proposal 13: Bring all regulation of trading under the Securities and Exchange Board of India (SEBI). Proposal 14: Encourage the introduction of markets that are currently missing such as exchange traded interest rate and exchange rate derivatives
Rajan Committee Recommendations Proposal 15: Stop creating investor uncertainty by banning markets. If market manipulation is the worry, take direct action against those suspected of manipulation Proposal 16: Create the concept of one consolidated membership of an exchange for qualified investors (instead of the current need to obtain memberships for each product traded). Consolidated membership should confer the right to trade all the exchange’s products on a unified trading screen with consolidated margining Proposal 17: Encourage the setting up of “professional” markets and exchanges with a higher order size, that are restricted to sophisticated investors (based on net worth and financial knowledge), where more sophisticated products can be traded.
Rajan Committee Recommendations Proposal 18: Create a more innovation-friendly environment, speeding up the process by which products are approved by focusing primarily on concerns of systemic risk, fraud, contract enforcement, transparency and inappropriate sales practices. The threshold for allowing products on professional exchanges (see Proposal 16) or Over the Counter markets should be lower, so that experimentation can take place Proposal 19: Allow greater participation of foreign investors in domestic markets as in Proposal 2. Increase participation of domestic investors by reducing the extent to which regulators restrict an institutional investor’s choice of investments. Move gradually instead to a “prudent man” principle where the institutional investor is allowed to exercise judgment based on what a prudent man might deem to be appropriate investments. Emphasize providing access to suitable equity-linked products to the broader population as part of the inclusion agenda
The role of financial markets in growth,stability and Inclusion Well functioning financial markets allow risks to be borne by investors It provides clear signals about which companies and sectors are doing well, which commodities are likely to be in short supply They can also bring the users of capital and savers together at low cost, eliminating layers of intermediation, and thus costs.
The role of financial markets in growth,stability and Inclusion Better risk sharing, better information signals, and lower costs combine to Reduce the cost of finance for firms, households and the government, allowing them to finance investment and innovation and growth Allow for better allocation of resources in the economy Equity and bond markets also serve as a buffer, passing losses from risky ventures to more fragile institutions Improve macroeconomic policy setting as well as transmission
Why are markets becoming moreimportant in India today? Corporations Indian firms have improved productive efficiency, increased their focus on R&D development with overseas investments moving towards greater technological risk Effect of exchange rate movements on competitiveness Equity Financing More important as India moves away from the asset-intensive mature industries of old to the human-capital-intensive industries of the future
Why are markets becoming moreimportant in India today? Virtues of Equity Financing Risk is spread across so that riskier, higher-return projects can be financed Not dominated by one bureaucratic view Control is not concentrated in a few financial institutions which could limit competition in the market Corporate and Government Debt Borrowing from bond markets rather than from banks can achieve a better asset liability match Reduce the risks the banking system is exposed to
Why are markets becoming moreimportant in India today? International Require international financial services as they turn themselves into multinational corporations, and engage more closely with the world economy Households and Diversification Many are over exposed to the Indian market and its fluctuations, and would well benefit from a more diversified global portfolio Indian firms and investors need better access and thus enhance production of international financial services
Are markets casinos? True that there is certain amount of luck in who makes money and who loses money in any single market transaction Need to understand that price fluctuation in financial markets does not mean more economic instability Flexible financial prices are a shock absorber Financial markets are far from casinos when they function well Have to create sound deep liquid markets by fostering transparency, competition, and enforcement against fraud ,so that can derive the maximum benefits from markets
Financial markets and competition Competition in the economy is fostered by a financial sector which is able to enable firm entry and growth by infusing debt and equity capital External financing is important from the view of competition in the economy Banks could play a role in nurturing new firms, typically are better at financing mature well understood technologies than green-field projects
The Inclusion Agenda Participation of more poor investors in Indian markets improve liquidity and depth, making them even less susceptible to unwarranted fluctuation Poor will be great beneficiaries from hedging markets when financial firms and NGOs improve their own levels of financial sophistication and the efficiency of transactions processes Cutting transactions costs of micro-payments (SIP) is also part of the inclusion agenda Need to find innovative ways for small businesses to raise debt and equity, to hedge their financial risks
Getting the Full range of Markets andits Effect on Policy Bond-Currency-Derivatives Nexus is the interlinked set of markets on government bonds, corporate bonds and currencies Implications when India achieves a well functioning BCD Nexus Enable funding the fiscal deficit at a lower cost Produce sound information about interest rates Would strengthen financing for debt-heavy infrastructure projects Would enable the `monetary policy transmission through changes in the short-term policy rate Financial markets produce a unique array of information including forecasts of volatility of all traded products further helpful in decision making
Markets and Risk-taking Participants have to develop a level of sophistication to use them well Corporations make losses all the time making real products, and will make them in financial products also Real regulatory concerns Do participants have a level of sophistication to understand the products and their consequences? Are products sold with adequate disclosure so that they can understand the risks they are taking? Are the systemic consequences of price movements in any direction likely to be limited?
The Need to Improve Liquidityand Market Efficiency Critical features of a well functioning financial market Market efficiency Extent to which information & forecasts about the future are impounded into financial prices High liquidity Immediacy is the ability to execute trades of small size immediately without moving the price adversely Depth refers to the impact cost suffered when doing large trades Resilience refers to the speed with which prices and liquidity of the market revert back to normal conditions after a large trade has taken place
The Need to Improve Liquidityand Market EfficiencyThe two concepts of efficiency and liquidity are linked in order formarkets to be efficient.Market efficiency assures uninformed participants that marketprices are up-to-date and reflect fundamentals, so they can tradesafely. This in turn provides volumes that ensure liquidity.
Diagnosing the sources of difficulty Why are so many markets illiquid and inefficient? Banned products and markets A market that is banned obviously cannot attain liquidity or efficiency Missing market can hamper the efficiency of other markets Restricted Participation These include outright bans, regulatory restrictions on some kinds of activities or quantitative restrictions Rationales for restriction Belief that some participants are new and therefore should proceed cautiously at the outset Desire to limit capital inflows and outflows so as to make exchange rate management easier
Diagnosing the sources of difficulty Restricted Participation Rationales for restriction Need to finance the government through restriction on investments other than government securities
Diagnosing the sources of difficulty Inadequacy of financial institutions Restrictions on ownership and shareholding especially to institutions like banks and exchanges, clearing corporations and depositories Limits on how much shares an individual shareholder can hold, limits on ownership by foreigners makes it difficult for new institutions to be started The way to resolve this problem is to increase competitive pressures in the market ecosystem by removing constraints for the entry of new players
Diagnosing the sources of difficulty Infirmities in Regulation India uses a `silo model where the financial markets are broken up across three agencies: SEBI, RBI, and FMC which reduce competition, hamper economies of scale and scope. Steep barriers to innovation are in place like approvals take years and no question of obtaining a temporary elevation of profitability Frictions caused by taxes Existence of a transaction tax reduces incentive for day traders & speculators to provide valuable liquidity to the market Disadvantage of low tax on mutual funds is debt fund investments are made only to make use of tax benefits
Proposals Reforms within existing legal and institutional framework Improvements in market design Rapid and Simplified product approval Professional Markets with light regulation Domestic Hedge Funds Staffing of regulatory institutions Uniform accounting treatment Securities Transaction Tax Remove segmentation within exchanges Restrictions on participation Fiduciary responsibility based on investment objectives Currency Derivatives Interest Rate Derivatives
Proposals Use Capital Account Liberalisation to Deepen Markets Broader participation for Foreign investors in the markets which Indian investors have little experience could allow more attractive debt structures to emerge and greater liquidity also Restrictions need to be eliminated with FII transactions on equities and equity derivatives Foreign mutual funds should be able to raise money directly in India, and Indian mutual funds should be able to raise money overseas to invest in India obtaining same tax treatment as FII
Proposals Modifications to legal framework and financial regulatory architecture Merger of all market regulation into SEBI will reduce transaction costs and improve liquidity in financial markets Enactment of a legislation that would bring all market regulations under a single roof, and ease the transition from a rule based approach to a principles based approach to regulation
Proposals Implement Debt Management Office Establishing independent Debt management offices (DMOs) which sell bonds for the government Rules that force financial firms to buy government bonds are relaxed and greater demands will be placed on the DMO