The Indian Capital Market Reforms

A capital market may be defined as an organised mechanism meant for effective and smooth

transfer of money capital or financial investors from the investors to the entrepreneurs. It is the

market for long term funds. It is market from where productive capital is raised or made

available for industrial purposes. It is consists of series of a channels through which the savings

of the community are made available for industrial purposes and commercial enterprises, and

public authorities. It involves those private savings, individual and corporate, which turned into

investments through capital issues and new public loans floated by governments and non-

government bodies.

Primary and Secondary Market:

The capital Market in India is classified into primary and secondary. The Primary capital

market deals with new issues of capital, so it also known as New Issue Market. The Secondary

capital market, which is known as Old Securities Market or Stock Exchange, deals with buying

and selling of old securities. The primary market creates long-term long-term instruments

through capital market. The two markets – primary and secondary always interact. The corporate

entities can enter the primary market and raise funds only if the secondary market is active. The

depth of the secondary market depends upon the activities of primary market because more

instruments are made available in the secondary market only when more corporate entities enter

into the primary market and raise funds from the market.

A company can raise its capital in the primary market through the issue of shares and debentures

by means of:

Public issue

Right issue

Bonus issue

Private placement

The secondary market is that segment of the capital market where outstanding securities are

traded. From the investor’s point of view this markets imparts liquidity of long term securities

held by them by providing an auction market for these securities. It operates through the medium

of stock exchanges which regulate the trading activities in this market and ensures a measure of

safety and fair dealing to the investors.

Debt Market

The debt market, however, is almost nonexistent in India even though there has been a large

volume of Government bonds traded. Banks and financial institutions have been holding a

substantial part of these bonds as statutory liquidity requirement. The portfolio restrictions on

financial institutions’ statutory liquidity requirement are still in place. A primary auction market

for Government securities has been created and a primary dealer system was introduced in 1995.

There are six authorized primary dealers. Currently, there are 31 mutual funds, out of which 21

are in the private sector. Mutual funds were opened to the private sector in1992. Earlier, in 1987,

banks were allowed to enter this business, breaking the monopoly of the Unit Trust of India

(UTI), which maintains a dominant position.

Government Securities Market

It a market where government securities are traded. This market is known as gilt-edged market.

The government securities market plays an important role with banks and financial institutions

by providing collateral that could be utilized for gaining financial support and liquidity without

creating a moral hazard. In India, there are two types of government securities, viz. (1) short term

(2) long term. The long term securities are traded in government securities market while the short

term securities in money market.

The government securities can be categorized into three depending on their maturities, viz. (1)

long-dated (2) medium-dated (3) short-dated. The long dated securities have maturities

exceeding 10 years from the issue date, and medium securities have maturities ranging from 5 to

10 years and short dated securities have maturities within 5 years. Depending on the issuing

body, such securities could be classified as:

Central Government securities

State Government securities

Securities guaranteed by Central government for all Indian financial institutions such as

IDBI, ICICI and IFCI.

Securities guaranteed by State government for state institutions, such as state electricity

boards and housing boards.

Treasury Bills issued by Reserve Bank of India.

Foreign Exchange Market

A foreign exchange market is a place where a foreign exchange is bought and sold. With the

growth of population and development of nations and political boundaries, it was found that each

nation was not sufficient in everything. Each country had to depend on other for goods and

services. Trading between nations thus developed and, as a result, a problem known as foreign

exchange emerged. The foreign exchange market provides the mechanism for exchanging

different monetary units for each other. It consists of a number of dealers, banks and brokers

engaged in business of buying and selling of foreign exchange. In this modern age, it is a market

whereby trading in foreign currency takes place through electronically linked network of banks’

foreign exchange brokers and dealers whose function is to bring buyers and sellers of foreign

exchange.

A foreign exchange market has following functions:

Transferring purchasing power from one country to another;

Promoting international trade by arranging credit card facilities;

Acting as intermediary between buyers and sellers; and

Helping to cover exchange risk by enabling the importers and exporters to enter into a

future transaction in the forward markets;

REFORMS IN CAPITAL MARKET

The Primary Capital Market:

The primary capital market has widened and deepened with public sectors banks,

financial institutions, and public sector enterprises in the infrastructure and power sectors

increasingly raising resources from the market both by way of debt and equity.

The securities and exchange board of India(SEBI) was set up in early 1988 as a non-

statutory body under an administrative arrangement. It was given statutory powers in

January 1992 through the enactment of the SEBI Act, 1992 for regulating the securities

market.

Merchant bankers are prohibited from carrying on fund-based activities other than those related

exclusively to the capital market. Multiple categories of merchant bankers have been abolished

and there is only one entity, the merchant banker.

To assist the retail investors, SEBI gave in-principle approval for grading of IPOs by the rating

agencies at the option of the issuers. SEBI will not certify the assessment made by the rating

agencies.

T he SEBI introduced the green-shoe option facility in IPO as a stabilization tool for the

post listing price of newly issued shares. Shares will now be allotted on a proportionate basis

within the specified categories, with the predetermined minimum application size.

The SEBI prescribed new guidelines for regulating private placements of debt securities issued

by the corporate. These guidelines aim to enhance transparency and protect the interest of

investors in the debt securities.

The Secondary Capital Market:

To enhance the level of investor protection, the process of dematerialization of securities through

the depository system and their transfer through electronic book entry in pursued strongly. To

enable this, the National Securities Depository Limited was set up in November 1996 and the

Central Depository Service Limited in February 1999. All actively traded securities are held,

traded, and settled in Demat form.

Badla-the carry forward trading mechanism was reinstated in January 1996, with safeguards in

line with the recommendations of Patel Committee (1995) and the varma committee (1996). All

deferral products including badla have been discontinued from July 2001 following the scam of

March 2001.

It is mandatory for listing companies to announce quarterly results. This enables investors to

keep close track of the scrip in their portfolios. The declaration of quarterly results is in line with

the practice prevailing in the stock market in the developed countries.

SEBI allowed mutual fund to invest in derivatives securities and also permitted to invest up to

10% of the net assets as on January 31 of each year in foreign securities with the limit of

minimum US $5 million and maximum US $50 million.

The restriction on short sales announced in March 7, 2001, was withdrawn with effect from July

2, 2001, as all deferral products stand banned after that date.

It is mandatory for all brokers to disclose all details of block deals. Block deals include trading

which accounts for more than 0.5% of the equity shares of that listed company.

In order to prevent off-market trades prior to the commencement of trading, the International

Securities Identification Numbers (ISINs) of IPOs will be activated by depositories only on the

date of commencement of trading on the stock exchanges.

An index-based market wide ‘circuit breaker’ system also been introduced to check a sudden rise

in security price, in speculation and over-trading.

REFORMS AND STATE OF CAPITAL MARKET

The capital market depends on the available savings and investment in the economy, on the other

hand, the performance of the industry and the economy in general. In particular, the government

policy, the psychological expectations and a host of other factors play a role in influencing the

capital market. At present only 1 to 4% of household savings in financial from is mobilized as

units of UTI and shares and debentures of the corporate sector, as against similar proportions of

around 25%- 20% in the USA and Japan.

New Capital Issues

The main indicator of the state of the capital market is the quantum of new capital issues floated

or raised. There has been a quantum jump into amount of new issues raised in the market over

last twelve years. Over the decade of eighties, capital issues rose by nearly 10 times. The volume

of resources rose from the capital market as new issues to public, right issues etc. has increased

substantially. In 1988-89, the public bond raised was for an aggregate amount of Rs.2566 crores,

and Rs. 14,265 crores in 2006-07.

Corporate Scenario

There are more than 2 lakh companies registered in India which shows strong upswing. More

than 6000 companies are listed on all exchanges in India. Their market capitalization at end

March 2007 was Rs.35, 45,041 crores, for companies listed on the BSE. Since 1995-96, NSE

emerged with a larger trade turnover than the BSE. Private corporate sector recorded a gross

capital Formation of 8% of GDP, during the quinquennium of 2002-2007 which was higher than

public investment at about 3% of GDP during the same period.

Secondary Market

The number of recognized stock exchanges has risen from 8 in 1980-81 to a total of 23 in 2004,

excluding OTCEI and NSE. The listed companies of all stock exchanges stood at more than 6000

in 2007. The value of turnover of trade has also increased nearly ten-fold over the twelve years to

around Rs. 10 lakh crores on the BSE and Rs. 19 lakh crores on the NSE, in 2006-07.

New Industrial Policy

Industrial policy measured announced in May 1990, also helped the process of liberalization

giving an impetus to the growth of the market. The emphasis was laid on the growth of export

industries, free entry to MRTP companies into many categories of industries, move to

privatization etc. the economic and financial reforms were started in July 1991. The Eighth plan

starting in 1992 has shifted emphasis to the promotion of agriculture, employment and

infrastructure industries. In April 1990, the government has imposed guidelines for stricter

control on public issues, rights, etc. The time gap between any two issues of bonus has been

reduced from 24 to 12 months in the case of all companies, early in 1990. The Government has

given powers to Stock Exchanges to shift from specified group to non- specified group, the

shares of a company issuing rights.

Narasimham Committee

A high level committee on the financial system with Shri M. Narasimham as the Chairman was

set up in 1991, which made far-reaching recommendations for banking sector and non-banking

financial sector to improve the flexibility and operational efficiency of the market and the

institutions, namely, banks and financial institutions. It also emphasized the need for

strengthening the SEBI powers, vesting of CCI powers in the SEBI.

Free Entry to Capital Market

I May 1992, the Capital Issues Control Act was abolished and the functions of capital issues

Controller were entrusted to SEBI. Any company is free to enter the capital market anytime to

raise any amount they want and at any price that they can justify to the SEBI and investors. The

SEBI powers in this regard are to oversee and vet the draft prospectus, with a view to ensuring

investor protection.

Liberalization Measures

Interest rates on debentures and on P.S.U. bonds were freed in August 1991 with the result that

they can now offer any rate to public depending on their credit rating. All debt instruments are to

be compulsorily credit rated by a credit rating agency. According, many private and joint sector

mutual funds, venture funds, and private banks have started operating since 1993-94. Nearly, 100

venture funds were cleared by the RBI until 2008, to operate in India. The ceiling rate if interest

on lending by financial institutions was replaced by a minimum lending rate of 15%. In 2003-04,

only 27 issues were made for Rs.3210 crores and in 2006-07, the amount was Rs. 31,600 crores.

SEBI Guidelines

The SEBI set up originally in April 1988, became a legal entity in March 1992 and has since

acquired larger and sweeping powers early in 1995. SEBI has issued Regulation for controlling

Insider Trading, frauds and malpractices, for Takeovers and Acquisitions, central depositories

and practices of brokers in particular of all Stock Exchanges. The SEBI guidelines have also

provided for market who will specialize in buying and selling of securities by offering two way

quotes. Regulations of underwriters of capital issues and capital adequacy norms for the stock

brokers in the recognized Stock Exchanges were announced in October 1993. Merchant bankers

are allowed a quota of 5% of post issue equity since October 1995.

Institutional strengthening

The reforms, included the setting up of OTCEI in August 1989,which started operations in

October 1992. The National Stock Exchange (NSE) was recognize by the govt. in 1993 and

started operations in 1994 and equity market which was launched in November 1994. In debt

segment, Money market instruments, PSU bonds, and Govt. securities are traded, while in the

equity segment there are presently 909 companies with a trading value of Rs. 4000- 6000 crores

or more per day on an average.

Electronic Trading

The OTCEI has started a new tier in the Stock trading operations, through the electronic media.

It is meant for smaller companies of Rs. 30 lakhs to Rs. 25 crores of paid up capital and

companies, which are venturesome and risky, due to new entrepreneurs, new products, long

gestation projects etc. are eligible to be listed here. With the introduction of BOLT, and its

becoming operational in May 1995, by the BSE and subsequent expansion to other centres with

terminals, a new era of electronic trading started, with NSE and BSE competing to set up on-line

trading terminals throughout the country.

Central Depository System

In September 1995, the Govt. have accepted in principle the proposed law for settling up of

depositories and of a central depository for immobilization of physical certificates. This is to be

sponsored by public financial institutions and banks and will have a minimum net worth of Rs.

50-100 crores, as proposed by the SEBI. This central depository can be connected to a number of

share depositories for effecting transfers in book entries. A National Securities Depository

Corporation was set up in November 1996, and the system of Demat Trading is now operative in

respect of almost all scrips, including CPs, gilted securities etc.

Banking

Prudential Measures: Measures to strengthen risk management through recognition of different

components of risk, assignment of risk-weights to various asset classes, norms on connected

lending, risk concentration, application of marked-to-market principle for investment portfolio

and limits on deployment of fund in sensitive activities.

Competition Enhancing Measures: Granting of operation autonomy to public sector banks,

reduction of public ownership in public sector banks by allowing them to raise capital from

equity market up to 49% of paid-up capital.

Measures Enhancing Role of Market Forces: Sharp reduction in pre-emption through reserve

requirement, market determined pricing for government securities, disbanding of administered

interest rates with a few exception and enhanced transparency and disclosure norms to facilitate

market discipline.

Institutional and Legal Measures: Setting up of Lok Adalats, debt recovery tribunals, asset

reconstruction companies, settlement advisory committees, corporate debt restructuring

mechanism, etc. for quicker recovery/restructuring. Setting up of Credit Information Bureau for

information sharing on defaulters as also other borrowers. Setting up Credit Information Bureau

for information sharing on defaulters as also other borrowers.

Supervisory Measures: Establishment of the Board for Financial Supervision as the apex

supervisory authority for commercial banks, financial institutions and non-banking financial

companies. Recasting of the role of statutory auditors, increased internal control through

strengthening of internal audit.

Technology Related Measures: Setting up of INFINET as the communication backbone for the

financial sector, introduction of Negotiated Dealing System (NDS) for screen-based trading in

government securities and Real Time Gross Settlement (RTGS) system.