Capital Markets critical for economic growth - White Paper by Mr. Shachindra Nath, Group Chief Executive Officer, Religare Enterprises Ltd.

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Capital Markets critical for economic growth
Capital markets and economic growth have a strong relationship. Empirical studies carried out by
researchers in the developed economies have established a strong correlation between capital markets
deepening and economic growth. Consequently, it is important that capital markets are further
deepened in an economy such as India for further and higher economic growth. The stock market
together with the banking systems enhance growth which aides in increasing quality of life eventually
reducing poverty. For example, the World Bank estimates that over 600 mn people have been pulled out
of poverty in China alone over the past thirty years.A stable and robust financial system provides access
to information that lowers transaction costs bolstering resource allocation and economic growth.
Capital market’s primary role is to be a conduit between the savers and the investors. The primary role
is to allocate funds to investment projects with the maximum return on capital. An efficient process of
pooling of funds and allocation of funds will create a virtuous cycle enabling economic growth.
A catalyst for sustaining growth
With a deep and mature capital market, an economy is able to promote and sustain growth. Mobilizing
and channeling funds from individuals/ institutions that have excess surplus to individual entrepreneurs/
small and medium enterprises and corporates which require funds to grow is the essential function of
capital markets. It acts as a major catalyst to transform an economy to a more efficient, innovative and
competitive economy within the global marketplace. Capital markets also act as a medium for risk
management as it encourages diversification of risk in the economy by spreading the funds. The efficient
performance of capital markets results in improvement in governance and information quality.
As increasingly foreign funds flow into India to tap into the growing opportunity, it is imperative that the
capital market is further deepened which will lead to higher economic growth.
Further development of capital markets
Increasing market participation
Moving household savings to the capital markets is an imperative. Create capital market products that
replicate the risks and returns of physical assets to capture the proportion of physical savings held for
investment purposes
 Grow gold-backed capital market products Gold Savings Schemes (GSS) - GSS is a new
product offered only by few players in India. However, given the potential of these products
to replicate the returns from gold, players should focus on three areas to deepen retail
participation in this space.
 Launch Real Estate Investment Trusts (REITs) to address investor needs not fulfilled by
products like Real Estate Portfolio Management Schemes. Till now in India, only venture
funds have been offering real estate funds available largely to high net worth individuals and
institutional and global investors due to the minimuminvestment size restriction.REITs can
take the form of pooled investments in both upcoming and existing income generating
properties to cater to different classes of investors. REITs act as a tax efficient tool as
income is distributed at regular intervals with no tax implications for the holder.

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 Improve mutual fund penetration across asset classes and introduce newer products like
Debt Infrastructure funds which are likely to create long term investment opportunity for
retail investors.
 Enhance investor awareness in tier II urban and semi-urban centres through investor camps
in key centres, nation-wide programmes with a focus on ethical selling practices by financial
services companies.
Regulatory reforms to encourage retail participation
There are three critical regulatory challenges which should be addressed to encourage greater retail
participation in the Indian equity markets:
1. Rationalizing the Securities Transaction Tax - The tax regime in India, with the introduction
of Securities transaction tax (STT) in the year 2004 has made the cost of transaction skewed
against cash trading (both delivery and intra-day). The STT for cash delivery transactions
today stands at about 730 times than the equivalent turnover in options. This difference
stands at 73 times between intra-day cash trading and options. This has led to a large skew
in turnover in the Futures &Options (F&O) segment. The ratio of F&O to cash turnover in the
Indian exchanges stand currently at 11: 1 against a global ratio of 2-2.5:1.
2. Uniformity in stamp duty charged by different states on equity transactions - The
government of Maharashtra, which accounts for 40 per cent equity volumes on the
country’s two biggest exchanges, doubled the stamp duty on equity transactions, in their
annual budget for 2011. A uniform duty of 0.005 per cent on all equity transaction was
mandated in comparison for the average of 0.0024 per cent in the cash segment and 0.002
per cent in the derivative segment.
3. Increasing domestic institutional investor participation by allowing higher investments by
pension funds in equities - Current regulations allow only about 10 percent of the pension
fund corpus of Rs. 6.4 trillion to be invested in the equities market directly or through
mutual funds. In contrast, internationally, up to 50 percent of pension fund is invested in
equities. Moving the Indian pension fund market closer to international levels could
potentially create equity inflows of up to Rs 2,500 billion at current levels, giving a much
needed boost to domestic institutional investor participation.
Deepen product markets
1. Deepen the Corporate Debt Market- Liquidity in the corporate bond market in India is
constrained. There are few changes which are likely to drive liquidity in the corporate bonds
market.
 Exempt corporate bond repos from the cash reserve ratio/statutory liquidity ratio
requirement to deepen the corporate bond repo market. The deepening of the
corporate bond repo market will likely drive significant activity in the bond markets.

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 Over time, create an integrated trading and settlement system for corporate bonds (like
the Negotiated Dealing System-Order Matching for government bonds) and move to a
clearing house guaranteed settlement system. Additionally, encourage investors with
larger bond holdings (insurance companies, pension funds) to trade in bonds rather
than letting them mature in order to create liquidity in the corporate bonds space.
2. Deepen the interest-rate futures market - Interest-rate derivatives are needed to hedge rate
risks, the largest macro-economic risk. Globally, interest rate derivatives constitute the
largest part of derivatives turnover on both exchange-traded as well as over the counter
products.
Conclusion
The capital markets in India have evolved considerably over the last two decades to create a strong
foundation for future economic growth. As the inter-linkages between global markets increases, the
capital market in India will need to hasten the process of transformation to a globally competitive
capital market to attract foreign capital. The way forward for the Indian capitalmarkets is continuous
regulatory reforms to adapt to the changing dynamics of the industry, increasing the use of technology
for easing the access to market, innovative products to increase choice as well as participation and
financial awareness for wider retail engagement – areas which are also consequence of a developed
capital market and a steady growth sustaining economy. Focus on these areas will strengthen the
foundation that has been already created since economic reforms.