The document discusses financial markets in India, including their relative size and growth over time. It provides data on the size and trading volumes of different market segments like equity, debt, currency and derivatives markets. It analyzes the role of these markets in India's economic growth and internationalization. It also discusses reforms needed to improve market liquidity, efficiency and participation, such as reducing restrictions, harmonizing regulations, and developing missing markets. The goal is for financial markets to more effectively mobilize savings and allocate resources towards productive investments and innovation.

1. Financial Markets in India
A Background

2. 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

3. Shareholding Pattern

4. Stock Market Performance

6. 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%

7. Primary Markets

8. Rise in listing

9. Stock, Debt, Currency and Derivative Markets

10. Most debt is privately placed

11. Bonds available for trading

12. G-Secs dominate trades

13. Who trades

14. Overnight rates

15. Roadblocks in the development
of 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.

16. Individual stock futures are
most popular

18. Liquidity

19. Access

20. Capabilities of Players

21. Mutual Funds

22. FII Flows
Cumulative FII Investment Since Nov 1992
(US($) billion)
80
70
60
50
billion USD
40
30
20
10
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Years

23. Stock
Exchange
s

24. Commodities
Derivatives Turnover at BSE & NSE
8.4 trillion
Turnover at MCX, Mar 08 3.6 trillion
Turnover at MCX, June 09 5.1 trillion

25. Creating More Efficient and
Liquid Markets

26. 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

27. 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.

28. 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

29. 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.

30. 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

31. Why are markets becoming more
important 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

32. Why are markets becoming more
important 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

33. Why are markets becoming more
important 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

34. 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

35. 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

36. 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

37. Getting the Full range of Markets and
its 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

38. 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?

39. The Need to Improve Liquidity
and 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

40. The Need to Improve Liquidity
and Market Efficiency
The two concepts of efficiency and liquidity are linked in order for
markets to be efficient.
Market efficiency assures uninformed participants that market
prices are up-to-date and reflect fundamentals, so they can trade
safely. This in turn provides volumes that ensure liquidity.

41. 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

42. Diagnosing the sources of difficulty
 Restricted Participation
 Rationales for restriction
 Need to finance the government through restriction on
investments other than government securities

43. 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

44. 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

45. 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

46. 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

47. 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

48. 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