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.
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.
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