Roll No. 13

1

“Evolution of Indian Financial

Markets”

Bachelor of Commerce

Financial Markets

Semester V

(2014-15)

Submitted by

Yash Hiranandani

H.R. COLLEGE OF COMMERCE & ECONOMICS

123, D.W. Road, Churchgate, Mumbai – 400 020.

Roll No - 13

H.R. COLLEGE OF COMMERCE & ECONOMICS

2

“Evolution of Indian Financial Markets”

Bachelor of Commerce

Financial Markets

Semester VIn Partial Fulfillment of the requirements

For the Award of Degree of Bachelor of

Commerce – Financial Markets

Submitted by

Yash Hiranandani

123, D.W. Road, Churchgate, Mumbai – 400020

H.R COLLEGE OF COMMERCE AND

ECONOMICS

123, D.W. Road, Churchgate, Mumbai – 400020

CERTIFICATE

This is to certify that Shri Yash Hiranandani

of B.Com.-Financial Markets Semester V

(2014- 2015 ) has successfully completed

the project on 21-09-2014 under the

guidance of Professor Meena Desai.

Principal

Project Guide

3

Internal Examiner External

Examiner

DECLARATION

I, Yash Sanjay Hiranandani the student of

B.Com.- Financial Markets Semester V

(2014 - 2015) hereby declare that I have

completed the Project on 21-09-2014.

The information submitted is true and

original to the best of my knowledge.

Signature of the Student

Name of the Student:

Yash Hiranandani

4

Roll No. 13

INDEX

Sr. No Topic Page No

1 Introduction 8

2 Money and Capital Market

10

3 Development of 26

Indian Financial

Market

4 Problems and 73

Solutions

5

Executive Summary

Financial Markets are the heart and soul of any nations

economy. The economic health of a country is dependant on

the performance of these financial markets such as Equities

Markets, Commodities Markets, Forex Markets etc. These

markets have existed since as far as back as the 1800’s.

Investors trade on these markets and the markets are

influenced by these activities. In this project I have focused on

the progress these markets have made over the years,

especially in recent times. I have focused on mainly on the

following markets:

Capital Markets: Stock markets and Bond markets

Commodity Markets

Money Markets

Derivatives Markets: Futures Markets

Insurance Markets

Foreign Exchange Markets

The Indian financial sector has undergone radical

transformation over the 1990s. Reforms have altered the

organizational structure, ownership pattern and domain of

operations of institutions and infused competition in the

financial sector. This has forced financial institutions to

reposition themselves in order to survive and grow. The

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extensive progress in technology has enabled markets to

graduate from outdated systems to modern business

processes, bringing about a significant reduction in the speed

of execution of trades and in transaction costs.

This project also compares these markets in the past and focuses

on the changes made over the years in these markets and how

these improvements have bettered the numbers and efficiency of

the financial sector in India.

Research Methodology Used

1. I spoke to family members who have had experience in

the financial markets and took their opinions into

consideration as they have seen the changes taken by the

government when it comes to the markets and also the

effects of these modifications.

2. I also researched and went through papers published by

experts on the Indian Financial System.

3. Went through old articles in business newspapers.

4. Went through official publications by NSE, BSE and RBI.

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Introduction

Indian Financial Market helps in promoting the savings of the

economy - helping to adopt an effective channel to transmit

various financial policies. The Indian financial sector is well-

developed, competitive, efficient and integrated to face all

shocks. In the India financial market there are various types of

financial products whose prices are determined by the

numerous buyers and sellers in the market. The other

determinant factor of the prices of the financial products is the

market forces of demand and supply. The various other types

of Indian markets help in the functioning of the wide India

financial sector.

What does the India Financial market comprise of? It talks

about the primary market, FDIs, alternative investment

options, banking and insurance and the pension sectors, asset

management segment as well. With all these elements in the

India Financial market, it happens to be one of the oldest

across the globe and is definitely the fastest growing and best

among all the financial markets of the emerging economies.

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The history of Indian capital markets spans back 200 years,

around the end of the 18th century. It was at this time that

India was under the rule of the East India Company. The

capital market of India initially developed around Mumbai;

with around 200 to 250 securities brokers participating in

active trade during the second half of the 19th century. 

The financial market in India at present is more advanced than

many other sectors as it became organized as early as the 19th

century with the securities exchanges in Mumbai, Ahmedabad

and Kolkata. In the early 1960s, the number of securities

exchanges in India became eight - including Mumbai,

Ahmedabad and Kolkata. Apart from these three exchanges,

there was the Madras, Kanpur, Delhi, Bangalore and Pune

exchanges as well. Today there are 23 regional securities

exchanges in India. 

The Indian Financial Markets can be divided into the

CapitalMarket and the Money Market as shown in the diagram

below

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MEANING OF MONEY MARKET:-

A money market is a market for borrowing and lending of

short-term funds. It deals in funds and financial instruments

having a maturity period of one day to one year. It is a

mechanism through which short-term funds are loaned or

borrowed and through which a large part of financial

transactions of a particular country or of the world are

cleared.

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It is different from stock market. It is not a single market

but a collection of markets for several instruments like call

money market, Commercial bill market etc. The Reserve Bank

of India is the most important constituent of Indian money

market. Thus RBI describes money market as “the centre for

dealings, mainly of a short-term character, in monetary assets,

it meets the short-term requirements of borrowers and

provides liquidity or cash to lenders”.

 PLAYERS OF MONEY MARKET :-

In money market transactions of large amount and high

volume take place. It is dominated by small number of large

players. In money market the players are :-Government, RBI,

DFHI (Discount and finance House of India) Banks, Mutual

Funds, Corporate Investors, Provident Funds, PSUs (Public

Sector Undertakings), NBFCs (Non-Banking Finance

Companies) etc.

The role and level of participation by each type of player

differs from that of others.

   FUNCTIONS OF MONEY MARKET :-

1) It caters to the short-term financial needs of the economy.

2) It helps the RBI in effective implementation of monetary policy.

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3) It provides mechanism to achieve equilibrium between demand

and supply of short-term

    funds.

4) It helps in allocation of short term funds through inter-bank

transactions and money market

    Instruments.

5) It also provides funds in non-inflationary way to

the government to meet its deficits.    

6) It facilitates economic development.

STRUCTURE OF INDIAN MONEY MARKET

 

I.       Organised Sector Of Money Market :-

Organised Money Market is not a single market, it consist

of number of markets. The most important feature of money

market instrument is that it is liquid. It is characterised by

high degree of safety of principal. Following are the

instruments which are traded in money market

1)        Call And Notice Money Market :-

The market for extremely short-period is referred as call

money market. Under call money market, funds are transacted

on overnight basis. The participants are mostly banks.

Therefore it is also called Inter-Bank Money Market. Under

notice money market funds are transacted for 2 days and 14

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days period. The lender issues a notice to the borrower 2 to 3

days before the funds are to be paid. On receipt of notice,

borrower have to repay the funds.

In this market the rate at which funds are borrowed and

lent is called the call money rate. The call money rate is

determined by demand and supply of short term funds. In call

money market the main participants are commercial banks, co-

operative banks and primary dealers. They participate as

borrowers and lenders. Discount and Finance House of India

(DFHI), Non-banking financial institutions like LIC, GIC, UTI,

NABARD etc. are allowed to participate in call money market

as lenders.

Call money markets are located in big commercial centres

like Mumbai, Kolkata, Chennai, Delhi etc. Call money market

is the indicator of liquidity position of money market. RBI

intervenes in call money market as there is close link between

the call money market and other segments of money market.

2)        Treasury Bill Market (T - Bills) :-

This market deals in Treasury Bills of short term duration

issued by RBI on behalf of Government of India. At present

three types of treasury bills are issued through auctions,

namely 91 day, 182 day and364day treasury bills. State

government does not issue any treasury bills. Interest is

determined by market forces. Treasury bills are available for a

minimum amount of Rs. 25,000 and in multiples of Rs. 25,000.

Periodic auctions are held for their Issue.

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T-bills are highly liquid, readily available; there is absence

of risk of default. In India T-bills have narrow market and are

undeveloped. Commercial Banks, Primary Dealers, Mutual

Funds, Corporates, Financial Institutions, Provident or Pension

Funds and Insurance Companies can participate in T-bills

market.

3)        Commercial Bills :-

Commercial bills are short term, negotiable and self

liquidating money market instruments with low risk. A bill of

exchange is drawn by a seller on the buyer to make payment

within a certain period of time. Generally, the maturity period

is of three months. Commercial bill can be resold a number of

times during the usance period of bill. The commercial bills

are purchased and discounted by commercial banks and are

rediscounted by financial institutions like EXIM banks, SIDBI,

IDBI etc.

In India, the commercial bill market is very much

underdeveloped. RBI is trying to develop the bill market in our

country. RBI have introduced an innovative instrument known

as “Derivative .Usance Promissory Notes, with a view to

eliminate movement of papers and to facilitate multiple

rediscounting.

4)        Certificate Of Deposits (CDs) :-

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CDs are issued by Commercial banks and development

financial institutions. CDs are unsecured, negotiable

promissory notes issued at a discount to the face value. The

scheme of CDs was introduced in 1989 by RBI. The main

purpose was to enable the commercial banks to raise funds

from market. At present, the maturity period of CDs ranges

from 3 months to 1 year. They are issued in multiples of Rs. 25

lakh subject to a minimum size of Rs. 1 crore. CDs can be

issued at discount to face value. They are freely transferable

but only after the lock-in-period of 45 days after the date of

issue.

In India the size of CDs market is quite small.

In 1992, RBI allowed four financial institutions ICICI, IDBI,

IFCI and IRBI to issue CDs with a maturity period of. one year

to three years.

5)        Commercial Papers (CP) :-

Commercial Papers wereintroduced in January 1990. The

Commercial Papers can be issued by listed company which

have working capital of not less than Rs. 5 crores. They could

be issued in multiple of Rs. 25 lakhs. The minimum size of

issue being Rs. 1 crore. At present the maturity period of CPs

ranges between 7 days to 1 year. CPs are issued at a discount

to its face value and redeemed at its face value.

6)        Money Market Mutual Funds (MMMFs) :-

A Scheme of MMMFs was introduced by RBI in 1992. The

goal was to provide an additional short-term avenue to

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individual investors. In November 1995 RBI made the scheme

more flexible. The existing guidelines allow banks, public

financial institutions and also private sector institutions to set

up MMMFs. The ceiling of Rs. 50 crores on the size of MMMFs

stipulated earlier, has been withdrawn. MMMFs are allowed to

issue units to corporate enterprises and others on par with

other mutual funds. Resources mobilised by MMMFs are now

required to be invested in call money, CD, CPs, Commercial

Bills arising out of genuine trade transactions, treasury bills

and government dated securities having an unexpired maturity

upto one year. Since March 7, 2000 MMMFs have been

brought under the purview of SEBI regulations. At present

there are 3 MMMFs in operation.

7)        The Repo Market ;-

Repo was introduced in December 1992. Repo is a

repurchase agreement. It means selling a security under an

agreement to repurchase it at a predetermined date and rate.

Repo transactions are affected between banks and financial

institutions and among bank themselves, RBI also undertake

Repo.

In November 1996, RBI introduced Reverse Repo. It means

buying a security on a spot basis with a commitment to resell

on a forward basis. Reverse Repo transactions are affected

with scheduled commercial banks and primary dealers.

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In March 2003, to broaden the Repo market, RBI allowed

NBFCs, Mutual Funds, Housing Finance and Companies and

Insurance Companies to undertake REPO transactions.

8)        Discount And Finance House Of India (DFHI)

In 1988, DFHI was set up by RBI. It is jointly owned by RBI,

public sector banks and all India financial institutions which

have contributed to its paid up capital.It is playing an

important role in developing an active secondary market in

Money Market Instruments. In February 1996, it was

accredited as a Primary Dealer (PD). The DFHI deals in

treasury bills, commercial bills, CDs, CPs, short term deposits,

call money market and government securities.

      Unorganised Sector Of Money Market :-

The economy on one hand performs through organised

sector and on other hand in rural areas there is continuance of

unorganised, informal and indigenous sector. The unorganised

money market mostly finances short-term financial needs of

farmers and small businessmen. The main constituents of

unorganised money market are:-

1)       Indigenous Bankers (IBs)

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Indigenous bankers are individuals or private firms who

receive deposits and give loans and thereby operate as banks.

IBs accept deposits as well as lend money. They mostly

operate in urban areas, especially in western and southern

regions of the country. The volume of their credit operations is

however not known. Further their lending operations are

completely unsupervised and unregulated. Over the years, the

significance of IBs has declined due to growing organised

banking sector.

2)       Money Lenders (MLs)

They are those whose primary business is money lending.

Money lending in India is very popular both in urban and rural

areas. Interest rates are generally high. Large amount of loans

are given for unproductive purposes. The operations of money

lenders are prompt, informal and flexible. The borrowers are

mostly poor farmers, artisans, petty traders and manual

workers. Over the years the role of money lenders has

declined due to the growing importance of organised banking

sector.

3)       Non - Banking Financial Companies (NBFCs)

They consist of :-

1.        Chit Funds

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Chit funds are savings institutions. It has regular members

who make periodic subscriptions to the fund. The beneficiary

may be selected by drawing of lots. Chit fund is more popular

in Kerala and Tamilnadu. Rbi has no control over the lending

activities of chit funds.

2.     Nidhis :-

Nidhis operate as a kind of mutual benefit for their

members only. The loans are given to members at a reasonable

rate of interest. Nidhis operate particularly in South India.

3.        Loan Or Finance Companies

Loan companies are found in all parts of the country. Their

total capital consists of borrowings, deposits and owned funds.

They give loans to retailers, wholesalers, artisans and self

employed persons. They offer a high rate of interest along with

other incentives to attract deposits. They charge high rate of

interest varying from 36% to 48% p.a.

4.        Finance Brokers

They are found in all major urban markets specially in

cloth, grain and commodity markets. They act as middlemen

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between lenders and borrowers. They charge commission for

their services.

FEATURES AND DEFICIENCIES OF INDIAN

MONEY MARKET

20

Indian money market is relatively underdeveloped when

compared with advanced markets like New York and London

Money Markets. Its' main features / defects are as follows

1.    Dichotomy:-

A major feature of Indian Money Market is the existence of

dichotomy i.e. existence of two markets: -Organised Money

Market and Unorganised Money Market. Organised Sector

consist of RBI, Commercial Banks, Financial Institutions etc.

The Unorganised Sector consist of IBs, MLs, Chit Funds,

Nidhis etc. It is difficult for RBI to integrate the Organised and

Unorganised Money Markets. Several segments are loosely

connected with each other. Thus there is dichotomy in Indian

Money Market.

2.    Lack Of Co-ordination And Integration :-

It is difficult for RBI to integrate the organised and

unorganised sector of money market. RBT is fully effective in

organised sector but unorganised market is out of RBI’s

control. Thus there is lack of integration between various sub-

markets as well as various institutions and agencies. There is

less co-ordination between co-operative and commercial banks

as well as State and Foreign banks. The indigenous bankers

have their own ways of doing business.

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3.    Diversity In Interest Rates :-

There are different rates of interest existing in different

segments of money market. In rural unorganised sectors the

rate of interest are high and they differ with the purpose and

borrower. There are differences in the interest rates within the

organised sector also. Although wide differences have been

narrowed down, yet the existing differences do hamper the

efficiency of money market.

4.    Seasonality Of Money Market :-

Indian agriculture is busy during the period November to

June resulting in heavy demand for funds. During this period

money market suffers from Monetary Shortage resulting in

high rate of interest. During slack season rate of interest falls

&s there are plenty offunds available. RBI has taken steps to

reduce the seasonal fluctuations, but still the variations exist.

5.    Shortage Of Funds :-

In Indian Money Market demand for funds exceeds the

supply. There is shortage of funds in Indian Money Market an

account of various factors like inadequate banking facilities,

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low savings, lack of banking habits, existence of parallel

economy etc. There is also vast amount of black money in the

country which have caused shortage of funds. However, in

recent years development of banking has improved the

mobilisation of funds to some extent.

6.    Absence Of Organised Bill Market :-

A bill market refers to a mechanism where bills of

exchange are purchased and discounted by banks in India. A

bill market provides short term funds to businessmen. The bill

market in India is not popular due to overdependence of cash

transactions, high discounting rates, problem of dishonour of

bills etc.

7.    Inadequate Banking Facilities :-

Though the commercial banks, have been opened on a

large scale, yet banking facilities are inadequate in our

country. The rural areas are not covered due to poverty. Their

savings are very small and mobilisation of small savings is

difficult. The involvement of banking system in different scams

and the failure of RBI to prevent these abuses of banking

system shows that Indian banking system is not yet a well

organised sector.

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CAPITAL MARKET

Capital market is a market where buyers and sellers engage in

trade of financial securities like bonds, stocks, etc. The

buying/selling is undertaken by participants such as

individuals and institutions.

Capital markets help channelise surplus funds from savers to

institutions which then invest them into productive use.

Generally, this market trades mostly in long-term securities.

Capital market consists of primary markets and secondary

markets. Primary markets deal with trade of new issues of

stocks and other securities, whereas secondary market deals

with the exchange of existing or previously-issued securities.

Another important division in the capital market is made on

the basis of the nature of security traded, i.e. stock market and

bond market.

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Capital market in any country consists of equity and the debt

markets. Within the debt market there are govt securities and

the corporate bond market. For developing countries, a liquid

corporate bond market can play a critical role in supporting

economic development as

It supplements the banking system to meet corporate sector’

requirements for long-term capital investment and asset

creation.

It provides a stable source of finance when the equity market

is volatile.

A well structures corporate bond market can have implications

on monetary policy of a country as bond markets can provide

relevant information about risks to price stability

Despite rapidly transforming financial sector and a fast

growing economy India's corporate bond market remains

underdeveloped. It is still dominated by the plain vanilla bank

loans and govt securities. The dominance of equities and

banking system can be gauged from the fact that since 1996,

India's stock market capitalisation as a percentage of GDP has

increased to 108% from 32.1%, while the banking sector's

ratio to GDP has risen from 46.3% to 78.2% in 2008. In

contrast, the bond markets grew to a modest 43.4 percent of

GDP from 21.3 percent. Of this corporate bonds account for

around 3.2% of GDP and government bond market accounts

for 38.3% of GDP.

India’s government bond market stands ahead of most East-

Asian emerging markets but most of it is used as a source of

25

financing the deficit. The size of the Indian corporate debt

market is very small in comparison with not only developed

markets, but also some of the emerging market economies in

Asia such as Malaysia, Thailand and China

Characteristics and features

Innovation and a Plethora of options:

Over time great innovations have been witnessed in the

corporate bond issuances, like floating rate instruments,

convertible bonds, callable (put-able) bonds, zero coupon

bonds and step-redemption bonds. This has brought a variety

that caters to a wider customer base and helps them maintain

strike a risk-return balance.

Preference for private placement:

26

In India, issuers tend to prefer Private Placement over public

issue as against USA where majority of corporate bonds are

publically issued.

In India while private placement grew 6.23 times to Rs.

62461.80 crores in 2000-01 since 1995-96, the corresponding

increase in public issues of debt has been merely 40.95

percent from the 1995-96 levels.This leads to a crunch in

market liquidity. A number of factors are responsible for such

preference. First, the companies can avoid the lengthy

issuance procedure for public issues. Second is the low cost of

private placement. Third, the amounts that can be raised

through private placements are typically larger. Fourth, the

structure of debt can be negotiated according to the needs of

the issuer. Finally, a corporate can expect to raise debt from

the market at finer rates than the PLR of banks and financial

institutions only with an AAA rated paper. This limits the

number of entities that would find it profitable to enter the

market directly. Even though the listing of privately placed

bonds has been made mandatory, a proper screening

mechanism is missing to take care of the quality and

transparency issues of private placement deals.

Dominance of financial institutions:

The public issues market has over the years been dominated

by financial institutions. The issuers who are the main

participants in other corporate bond markets (that is, private

sector, non-financial), represent only a small proportion of the

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corporate debt issues in the Indian market. Most of the

privately placed bonds (which are about 90% of the total issue

of corporate bonds) are issued by the financial and the public

sector.

Inefficient secondary market:

Further the secondary market for non-sovereign debt,

especially corporate paper still remains plagued by

inefficiencies. The primary problem is the total lack of market

making in these securities, which consequently leads to poor

liquidity. The biggest investors in this segment of the market,

namely LIC, UTI prefer to hold these instruments to maturity,

thereby holding the supply of paper in the market.

The listed corporate bonds also trade on the Wholesale Debt

Segment of NSE. But the percentage of the bonds trading on

the exchange is small. Number of trades in debt compared to

equity on average for August 2007 is just 0.003%.

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DEVELOPMENT OF INDIAN FINANCIAL

MARKETS

As all the Financial Markets in India together form the Indian

Financial Markets, all the Financial Markets of Asia together

form the Asian Financial Markets; likewise all the Financial

Markets of all the countries of the world together form the

Global Financial Markets. Financial Markets deal with trading

(buying and selling) of financial securities (stocks and bonds),

commodities (valuable metals or food grains), and other

exchangeable and valuable items at minimum transaction

costs and market efficient prices. Financial Markets can be

domestic or international. The Global Financial Markets work

as a significant instrument for improved liquidity.

Financial Markets can be categorized into six types:

Capital Markets: Stock markets and Bond markets

Commodity Markets

Money Markets

Derivatives Markets: Futures Markets

Insurance Markets

Foreign Exchange Markets

 

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In recognition of the critical role of the financial markets, the

initiation of the structural reforms in the early 1990s in India

also encompassed a process of phased and coordinated

deregulation and

liberalisation of financial markets. Financial markets in India

in the period before the early 1990s were marked by

administered interest rates, quantitative ceilings, statutory

pre-emptions, captive market for government securities,

excessive reliance on central bank financing, pegged exchange

rate, and current and capital account restrictions. As a result

of various reforms, the financial markets have transited to a

regime characterised by market-determined interest and

exchange rates, price-based instruments of monetary policy,

current account convertibility, phased capital account

liberalisation and an auction-based system in the government

securities market.

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Money market

The Reserve Bank has accorded prime attention to the

development of the money market as it is the key link in the

transmission mechanism of monetary policy to financial

markets and finally, to the real economy (Annex I). In the past,

development of the money market was hindered by a system of

administered interest rates and lack of proper accounting and

risk management systems. With the initiation of reforms and

the transition to indirect, market-based instruments of

monetary policy in the 1990s, the Reserve Bank made

conscious efforts to develop an efficient, stable and liquid

money market by creating a favourable policy environment

31

through appropriate institutional changes, instruments,

technologies and market practices. Accordingly, the call

money market was developed into primarily an inter-bank

market, while encouraging other market participants to

migrate towards collateralised segments of the market,

thereby increasing overall market integrity.

In line with the objective of widening and deepening of the

money market and imparting greater liquidity to the market

for facilitating efficient price discovery, new instruments, such

as collateralised lending and borrowing obligations (CBLO),

have been introduced. Money market instruments such as

market repo and CBLO have provided avenues for non-banks

to manage their short-term liquidity mismatches and

facilitated the transformation of the call money market into a

pure inter-bank market.

Furthermore, issuance norms and maturity profiles of other

money market instruments such as commercial paper (CP) and

certificate of deposits (CDs) have been modified over time to

encourage wider participation while strengthening the

transmission of policy signals across the various market

segments. The abolition of ad hoc Treasury Bills and

introduction of regular auctions of Treasury Bills paved the

way for the emergence of a risk free rate, which has become a

benchmark for pricing the other money market instruments.

Concomitantly, with the increased market orientation of

monetary policy along with greater global integration of

domestic markets, the Reserve Bank’s emphasis has been on

setting prudential limits on borrowing and lending in the call

32

money market, encouraging migration towards the

collateralised segments and developing derivative instruments

for hedging market risks. This has been complemented by the

institutionalisation of the Clearing Corporation of India

Limited (CCIL) as a central counterparty. The upgradation of

payment system technologies has also enabled market

participants to improve their asset liability management. All

these measures have

After the adoption of the full-fledged LAF in June 2000, call

rates, in general, witnessed a declining trend up to 2004-05.

The institution of LAF has also enabled the Reserve Bank to

manage liquidity more efficiently and reduce volatility in call

rates. Volatility, measured by the coefficient of variation (CV)

of call rates, has declined significantly in the current decade as

compared with that in the 1990s, with some increase in 2006-

07, as already noted. BIS Review 51/2007. The reduction in

bid-ask spread in the overnight rates indicates that the Indian

money market has become reasonably deep, vibrant and

liquid. During April 2004−February 2007, the bid-ask spread

has varied within a range of -0.37 to +1.32 basis points with

an average of 16 basis points and standard deviation (SD) of

11 basis points (coefficient of variation being 68.8). Despite a

higher degree of variation, however, the bid-ask spread

remained within the 2-SD band around the average during

most of the period.

Interim Liquidity Adjustment Facility (ILAF) in April 1999,

under which liquidity injection was done at the Bank Rate and

liquidity absorption was through fixed reverse repo rate. The

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ILAF gradually transited into a full-fledged liquidity

adjustment facility (LAF) with periodic modifications based on

experience and development of financial markets and the

payment system. The LAF was operated through overnight

fixed rate repo and reverse repo from November 2004, which

provided an informal corridor for the call money rate. Though

the LAF helped to develop interest rate as an instrument of

monetary transmission, two major weaknesses came to the

fore. First was the lack of a single policy rate, as the operating

policy rate alternated between repo during deficit liquidity

situation and reverse repo rate during surplus liquidity

condition. Second was the lack of a firm corridor, as the

effective overnight interest rates dipped (rose) below (above)

the reverse repo (repo) rate in extreme surplus (deficit)

conditions. Recognising these shortcomings, a new operating

procedure was put in place in May 2011.

These are the key features of the new operating procedure.

First, the weighted average overnight call money rate was

explicitly recognised as the operating target of monetary

policy. Second, the repo rate was made the only one

independently varying policy rate. Third, a new Marginal

Standing Facility (MSF) was instituted under which scheduled

commercial banks (SCBs) could borrow overnight at 100 basis

points above the repo rate up to one per cent of their

respective net demand and time liabilities (NDTL). This limit

was subsequently raised to two per cent of NDTL and in

addition, SCBs were allowed to borrow funds under MSF on

overnight basis against their excess SLR holdings as well.

34

Moreover, the Bank Rate being the discount rate was aligned

to the MSF rate. Fourth, the revised corridor was defined with

a fixed width of 200 basis points. The repo rate was placed in

the middle of the corridor, with the reverse repo rate at 100

basis points below it and the MSF rate as well as the Bank

Rate at 100 basis points above it. Thus, under the new

operating procedure, all the three other rates announced by

the Reserve Bank, i.e., reverse repo rate, MSF rate and the

Bank Rate, are linked to the single policy repo rate. The new

operating procedure was expected to improve the

implementation and transmission of monetary policy for the

following reasons. First, explicit announcement of an operating

target makes market participants clear about the desired

policy impact. Second, a single policy rate removes the

confusion arising out of policy rate alternating between the

repo and the reverse repo rates, and makes signalling of

monetary policy stance more accurate. Third, MSF provides a

safety valve against unanticipated liquidity shocks. Fourth, a

fixed interest rate corridor set by MSF rate and reverse repo

rate, reduces uncertainty and communication difficulties and

helps keep the overnight average call money rate close to the

repo rate.

Since May 2011, the liquidity conditions can be broadly

divided into three distinct phases.

After generally remaining within the Reserve Bank’s comfort

zone during the first phase during May–October 2011, the

35

liquidity deficit crossed the one per cent of NDTL level during

November 2011 to June 2012. This large liquidity deficit was

mainly caused by forex intervention and increased divergence

between credit and deposit growth. The deficit conditions were

further aggravated by frictional factors like the build-up of

government cash balances with the Reserve Bank that

persisted longer than anticipated and the increase in currency

in circulation. Accordingly, the Reserve Bank had to actively

manage liquidity through injection of liquidity by way of open

market operations (OMOs) and cut in cash reserve ratio (CRR)

of banks. This was supported by decline in currency in

circulation and a reduction in government cash balances with

the Reserve Bank. As a result, there was a significant easing of

liquidity conditions since July 2012 with the extent of the

deficit broadly returning to the Reserve Bank’s comfort level of

one per cent of NDTL.

Second, the repo rate and weighted call rate are far more

closely aligned under the new operating procedure than

earlier; implying improved transmission of monetary policy in

terms of movement in call money market interest rate

Third, the call money rate in turn is observed to be better

aligned with other money market interest rates after the

implementation of new operating procedure than before

36

As a result of various reform measures, the money market in

India has undergone significant transformation in terms of

volume, number of instruments and participants and

development of risk management practices. In line with the

shifts in policy emphasis, various segments of the money

market have acquired greater depth and liquidity. The price

discovery process has also improved. The call money market

has been transformed into a pure inter-bank market, while

other money market instruments such as market repo and

CBLO have developed to provide avenues to non-banks for

managing their short-term liquidity mismatches. The money

market has also become more efficient as is reflected in the

narrowing of the bid-ask spread in overnight rates. The

abolition of ad hoc Treasury Bills and introduction of Treasury

Bills auction have led to the emergence of a risk free rate,

which acts as a benchmark for the pricing of other money

market instruments.

In the development of various constituents of the money

market, the most significant aspect was the growth of the

collateralised market vis-à-vis the uncollateralised market.

Over the last decade, while the daily turnover in the call

money market either stagnated or declined, that of the

collateralised segment, market repo plus CBLO, increased

manifold. Since 2007–08, both the CP and CD volumes have

also increased very significantly. Furthermore, issuance of 91-

treasury bills has also increased sharply. The overall money

market now is much larger relative to GDP than a decade ago.

37

Major Developments in Money Market since the

1990s

1. Abolition of ad hoc treasury bills in April 1997

2. Full fledged LAF in June 2000.

3. CBLO for corporate and non-bank participants introduced in

2003

4. Minimum maturity of CPs shortened by October 2004

5. Prudential limits on exposure of banks and PDs to call/notice

market in April 2005

6. Maturity of CDs gradually shortened by April 2005

7. Transformation of call money market into a pure inter-bank

market by August 2005

8. Widening of collateral base by making state government

securities (SDLs) eligible for LAF operations since April 2007

9. Operationalisation of a screen-based negotiated system

(NDS-CALL) for all dealings in the call/notice and the term

money markets in September 2006. The reporting of all such

38

transactions made compulsory through NDS-CALL in

November 2012.

10. Repo in corporate bonds allowed in March 2010.

11. Operationalisation of a reporting platform for secondary

market transactions in CPs and CDs in July 2010.

Government securities and Capital market

The Reserve Bank has actively pursued the development of the

government securities market since the early 1990s for a

variety of reasons (Annex II). First, with the Reserve Bank

acting as the debt manager to the Government, a well-

developed and liquid government securities market is essential

to ensure the smooth passage of Government’s market

borrowings to finance its deficit. Second, the development of

the government securities market is also necessary to

39

facilitate the emergence of a risk free rupee yield curve to

serve as a benchmark for pricing other debt instruments.

Finally, the government securities market plays a key role in

the effective transmission of monetary policy impulses in a

deregulated environment.

In order to foster the development of the government

securities market, it was imperative to migrate from a regime

of administered interest rates to a market-oriented system.

Accordingly, in the early 1990s, the Reserve Bank initiated

several measures. First, it introduced the auction system for

issuance of government securities. While initially only yield-

based multiple price auctions were conducted, uniform price-

based auctions were also employed during uncertain market

conditions and while issuing new instruments. Second, as the

captive investor base was viewed as constraining the

development of the market, the statutory prescription for

banks’ investments in government and other approved

securities was scaled down from the peak level in February

1992 to the statutory minimum level of 25 per cent by April

1997. As a result, the focus shifted towards the widening of

the investor base. A network of intermediaries in the form of

primary dealers was developed for this purpose. Retail

participation has been promoted in the primary market

(through a system of non-competitive bidding in the auctions)

as well as in the secondary market (by allowing retail trading

in stock exchanges). Simultaneously, the Reserve Bank also

introduced new instruments with innovative features to cater

to perse market preferences, although the experience in this

40

regard has not been encouraging. Third, with the

discontinuance of the process of unconstrained recourse by

the Government to the Reserve Bank through automatic

monetisation of deficit and conversion of non-marketable

securities to marketable securities, the Reserve Bank gained

more operational freedom. Fourth, in an effort to increase

liquidity, the Reserve Bank has, since the late 1990s, pursued

a strategy of passive consolidation of debt by raising

progressively higher share of market borrowings through re-

issuances. This has resulted in critical mass in key maturities,

and is facilitating the emergence of market benchmarks. Fifth,

improvement in overall macroeconomic and monetary

management that has resulted in lower inflation, lower

inflation expectations, and price stability has enabled the

elongation of the yield curve to maturities upto 30 years.

Finally, the Reserve Bank has also undertaken measures to

strengthen the technological infrastructure for trading and

settlement. A screen-based anonymous trading and reporting

platform has been introduced in the form of NDS-OM, which

enables electronic bidding in primary auctions and

disseminates trading information with a minimum time lag.

Furthermore, with the setting up of CCIL, an efficient

settlement mechanism has also been institutionalised, which

has imparted considerable stability to the government

securities market. With the withdrawal from the primary

market from April 1, 2006 in accordance with the FRBM

(Fiscal Responsibility and Budget Management Act)

stipulations, the Reserve Bank introduced various institutional

41

changes in the form of revamping and widening of the

coverage of the Primary Dealer (PD) system to meet the

emerging challenges. Other measures taken to deepen the

market and promote liquidity include introduction of “when

issued” trading, “short selling” of government securities and

active consolidation of government debt through buy backs.

Various policy initiatives taken by the Reserve Bank over the

years to widen and deepen the government securities market

in terms of instruments as well as participants have enabled

successful completion of market borrowing programmes of the

Government under varied circumstances. In particular, a

smooth transition to the post-FRBM phase has been ensured.

The system of automatic monetisation through ad hoc Treasury

Bills was replaced with Ways and Means Advances in 1997,

because of which the Government resorted to increased

market borrowings to finance its deficit. Accordingly, the size

of the government securities market has increased

significantly over the years.

One of the key issues in the development of the market for a

better price discovery is liquidity of securities. It was observed

that, of the universe of a large number of outstanding

securities, only a few securities are actively traded in the

secondary market. The Reserve Bank has been following a

policy of passive consolidation through re-issuance of existing

securities with a view to enhancing liquidity in the secondary

segment of the government securities market. The share of re-

issuances in the total securities issued was 97.7 per cent

during 2005-06. Active consolidation of government securities

42

has also been attempted under the debt buyback scheme

introduced in July 2003, which is expected to be more actively

pursued now. As a result of the developmental measures

undertaken, the volume of transactions has increased manifold

over the past decade.

To keep the markets liquid and active even during the bearish

times, and more importantly, to give the participants a tool to

better manage their interest rate risk, intra-day short selling in

government securities was permitted among eligible

participants, viz., scheduled commercial banks (SCBs) and

primary dealers (PDs) in February 2006. Subsequently, the

short positions were permitted to be carried beyond intra-day

for a period of five trading days, effective January 31, 2007. To

further improve the liquidity in the government securities

market, guidelines for trading in when issued “WI” market

were issued by the Reserve Bank in May, 2006. Trading in

“WI” segment, which commenced in August 2006, was initially

permitted in reissued securities. It takes place from the date of

announcement of auction till one day prior to allotment of

auctioned securities. The revised guidelines extending “WI”

trading to new issuances of Central Government securities on

a selective basis were issued in November 2006.

In developed economies, bond markets tend to be bigger in

size than the equity market. A well-developed capital market

consists of both the equity market and the bond market. In

India, equity

43

markets are more popular and far developed than the debt

markets. The Indian debt market is composed of government

bonds and corporate bonds. However, the government bonds

are

predominant (constituting 92% of the volume) and they form

the liquid component of the bond market. An active corporate

bond market is essential for India Inc. The corporate bond

market is still at the nascent stage. Although we have the

largest number of listed companies on the capital market, the

share of corporate bonds in GDP is merely 3.3%, compared to

10.6% in China 41.7% in Japan, 49.3% in Korea among others.

Further, close to 80% of corporate bonds comprises privately

placed debt of public financial institutions. The secondary

market, therefore, has not developed commensurately. Though

there has been an increase in the volumes, the trading activity

is still negligible in the secondary markets. If we look at the

ratio of secondary market volume to primary market volume,

the ratio is below 1 indicating very low trading activity in the

secondary market.

Over the past few years, some significant reforms have been

undertaken to develop the bond market and particularly the

corporate bond market. The listing requirements for corporate

debt have been simplified. Issuers now need to obtain rating

from only one credit rating agency unlike earlier. Further, they

are permitted to structure debt instruments, and are allowed

to do a public issue of below investment grade bonds. One

more welcome change was, the exemption of TDS on corporate

44

debt instruments issued in demat form and on recognized

stock exchanges.Data released by SEBI indicates that

companies raised Rs 2.12 lakh crore through corporate bonds

in 2009-10, up 22.71% from Rs 1.73 lakh crore in 2008-09.

India has witnessed a boost in trading in the recent past. Total

trading in corporate bonds more than doubled from an average

of Rs. 1,550 crore in October 2009 to Rs 3,356 crore in March

2010, as reported by the National Stock Exchange and the

Bombay Stock Exchange

45

Foreign exchange market

Happenings in the foreign exchange market (henceforth forex

market) form the essence of the international finance. The

foreign exchange market is not limited by any geographical

boundaries. It does not have any regular market timings,

operates 24 hours 7 days week 365 days a year, characterized

by ever-growing trading volume, exhibits great heterogeneity

among market participants with big institutional investor

46

buying and selling million of dollars at one go to individuals

buying or selling less than 100 dollar.

Traditionally Indian forex market has been a highly regulated

one. Till about 1992-93, government exercised absolute control

on the exchange rate, export-import policy, FDI ( Foreign

Direct Investment) policy. The Foreign Exchange Regulation

Act(FERA)enacted in 1973, strictly controlled any activities in

any remote way related to foreign exchange. FERA was

introduced during 1973, when foreign exchange was a scarce

commodity. Post independence, union government’s socialistic

way of managing business and the license raj made the Indian

companies noncompetitive in the international market, leading

to decline in export. Simultaneously India import bill because

of capital goods, crude oil &petrol products increased the

forex outgo leading to sever scarcity of foreign exchange.

FERA was enacted so that all forex earnings by companies and

residents have to reported and surrendered (immediately after

receiving) to RBI (Reserve Bank of India) at a rate which was

mandated by RBI. FERA was given the real power by making

“any violation of FERA was a criminal offense liable to

imprisonment”. It a professed a policy of “a person is guilty of

forex violations unless he proves that he has not violated any

norms of FERA”. To sum up, FERA prescribed a policy –

“nothing (forex transactions) is permitted unless specifically

mentioned in the act”. Post liberalization, the Government of

India, felt the necessity to liberalize the foreign exchange

policy. Hence, Foreign Exchange Management Act (FEMA)

47

2000 was introduced. FEMA expanded the list of activities in

which a person/company can undertake forex transactions.

Through FEMA, government liberalized the export-import

policy, limits of FDI (Foreign Direct Investment) & FII (Foreign

Institutional Investors) investments and repatriations, cross-

border M&A and fund raising activities. Prior to 1992,

Government of India strictly controlled the exchange rate.

After 1992, Government of India slowly started relaxing the

control and exchange rate became more and more market

determined. Foreign Exchange Dealer’s association of India

(FEDAI), set up in 1958, helped the government of India in

framing rules and regulation to conduct forex exchange

trading and developing forex market In India.

The Indian foreign exchange market has witnessed far

reaching changes since the early 1990s following the phased

transition from a pegged exchange rate regime to a market

determined exchange rate regime in 1993 and the subsequent

adoption of current account convertibility in 1994 and

substantial liberalisation of capital account transactions

(Annex III). Market participants have also been provided with

greater flexibility to undertake foreign exchange operations

and manage their risks. This has been facilitated through

simplification of procedures and availability of several new

instruments.

There has also been significant improvement in market

infrastructure in terms of trading platform and settlement

mechanisms. As a result of various reform measures, liquidity

48

in the foreign exchange market increased by more than five

times between 1997-98 and 2006-07.

In relative terms, turnover in the foreign exchange market was

6.6 times the size of India's balance of payments during 2005-

06 as compared with 5.4 times in 2000-01. With the deepening

of the foreign exchange market and increased turnover,

income of commercial banks through such transactions

increased significantly. Profit from foreign exchange

transactions accounted for more than 20 per cent of total

profit of scheduled commercial banks in the last 2 years.

Efficiency in the foreign exchange market has also improved

as reflected in the decline in bid-ask spreads. The bid-ask

spread of Rupee/US$ market has almost converged with that

of other major currencies in the international market. On some

occasions, in fact, the bid-ask spread of Rupee/US$ market

was lower than that of some major currencies

The EMEs’ experience, in general, in the 1990s has

highlighted the growing importance of capital flows in

determining the exchange rate movements as against trade

flows and economic growth in the 1980s and before. In the

case of most developing countries, which specialise in labour-

intensive and low and intermediate technology products, profit

margins in the highly competitive markets are very thin and

vulnerable to pricing power by large retail chains.

Consequently, exchange rate volatility has significant

employment, output and distributional consequences. Foreign

49

exchange market conditions have remained orderly in the post-

1993 period, barring occasional periods of volatility. The

Indian approach to exchange rate management has been to

avoid excessive volatility. Intervention by the Reserve Bank in

the foreign exchange market, however, has been relatively

small compared to total turnover in the market.

As a result of various measures, the Indian foreign exchange

market has evolved into a relatively mature market over a

period of time with increase in depth and liquidity. The

turnover in the market has increased over the years. With the

gradual opening up of the capital account, the forward premia

are getting increasingly aligned with the interest rate

differential. There is also evidence of enhanced efficiency in

the foreign exchange market as is reflected in low bid-ask

spreads. The gradual development of the foreign exchange

market has helped in smooth implementation of current

account convertibility and the phased and gradual opening of

the capital account. The availability of derivatives is also

helping domestic entities and foreign investors in their risk

management. This approach has helped India in being able to

maintain financial stability right through the period of

economic reforms and liberalisation leading to continuing

opening of the economy, despite a great degree of volatility in

international markets, particularly during the 1990s.

1947 to1977: During 1947 to 1971, India exchange rate

system followed the par value system. RBI fixed rupee’s

50

external par value at 4.15 grains of fine gold. 15.432grains of

gold is equivalent to 1 gram of gold. RBI allowed the par value

to fluctuate within the permitted margin of ±1 percent. With

the breakdown of the Bretton Woods System in 1971 and the

floatation of major currencies, the rupee was linked with

Pound-Sterling. Since Pound-Sterling was fixed in terms of US

dollar under the Smithsonian Agreement of 1971, the rupee

also remained stable against dollar.

1978-1992: During this period, exchange rate of the rupee was

officially determined in terms of a weighted basket of

currencies of India’s major trading partners. During this

period, RBI set the rate by daily announcing the buying and

selling rates to authorized dealers. In other words, RBI

instructed authorized dealers to buy and sell foreign currency

at the rate given by the RBI on daily basis. Hence exchange

rate fluctuated but within a certain range. RBI managed the

exchange rate in such a manner so that it primarily facilitates

imports to India. As mentioned in Section 5.1, the FERA Act

was part of the exchange rate regulation practices followed by

RBI. Joint Initiative IITs and IISc – Funded by MHRD - 4 -

NPTEL International Finance Vinod Gupta School of

Managment , IIT. Kharagpur India’s perennial trade deficit

widened during this period. By the beginning of 1991, Indian

foreign exchange reserve had dwindled down to such a level

that it could barely be sufficient for three-week’s worth of

imports. During June 1991, India airlifted 67 tonnes of gold,

pledged these with Union Bank of Switzerland and Bank of

England, and raised US$ 605 millions to shore up its

51

precarious forex reserve. At the height of the crisis, between

2nd and 4th June 1991, rupee was officially devalued by 19.5%

from 20.5 to 24.5 to 1 US$. This crisis paved the path to the

famed “liberalization program” of government of India to make

rules and regulations pertaining to foreign trade, investment,

public finance and exchange rate encompassing a broad gamut

of economic activities more market oriented.

1992 onwards: 1992 marked a watershed in India’s economic

condition. During this period, it was felt that India needs to

have an integrated policy combining various aspects of trade,

industry, foreign investment, exchange rate, public finance

and the financial sector to create a market-oriented

environment. Many policy changes were brought in covering

different aspects of import-export, FDI, Foreign Portfolio

Investment etc. One important policy changes pertinent to

India’s forex exchange system was brought in -- rupees was

made convertible in current account. This paved to the path of

foreign exchange payments/receipts to be converted at

market-determined exchange rate. However, it is worthwhile

to mention here that changes brought in by government of

India to make the exchange rate market oriented have not

happened in one big bang. This process has been gradual.

52

Commodity Market

Commodity futures markets largely remain underdeveloped in

India. This is in spite of the country‘s long history of

commodity derivatives trade as compared to the US and UK. A

major contributor to this fact is the extensive government

intervention in the agricultural sector in the post-

independence era. In reality, the production and distribution of

several agricultural commodities is still governed by the state

and forwards as well as futures trading have only been

selectively introduced with stringent regulatory controls. Free

trade in many commodity items remains restricted under the

Essential Commodities Act (ECA), 1955, and forwards as well

53

as future contracts are limited to specific commodity items

listed under the Forward Contracts (Regulation) Act (FCRA),

1952.

 

The evolution of the organized futures market in India

commenced in 1875 with the setting up of the Bombay Cotton

Trade Association Ltd. Following widespread discontent

among leading cotton mill owners and merchants over the

functioning of the Bombay Cotton Trade Association, a

separate association, Bombay Cotton Exchange Ltd., was

constituted in 1983. Futures trading in oilseeds originated

with the setting up of the Gujarati VyapariMandali in 1900,

which carried out futures trading in ground nuts, castor seeds

and cotton. The Calcutta Hessian Exchange Ltd. and the East

India Jute Association Ltd. were set up in 1919 and 1927

respectively for futures trade in raw jute. In 1921, futures in

cotton were organized in Mumbai under the auspices of East

India Cotton Association (EICA). Before the Second World War

broke out in 1939, several futures markets in oilseeds were

functioning in the states of Gujarat and Punjab. Futures

markets in Bullion began in Mumbai in 1920, and later, similar

markets were established in Rajkot, Jaipur, Jamnagar, Kanpur,

Delhi and Calcutta. In due course, several other exchanges

were established in the country, facilitating trade in diverse

commodities such as pepper, turmeric, potato, sugar and

jaggery.

 

54

Post independence, the Indian constitution listed the subject of

―Stock Exchanges and Future Markets under the union list.

As a result, the regulation and development of the

commodities futures markets were defined solely as the

responsibility of the central government. A bill on forward

contracts was referred to an expert committee headed by Prof.

A.D. Shroff and selected committees of two successive

parliaments and finally, in December 1952, the Forward

Contracts (Regulation) Act was enacted. The Forward

Contracts (Regulation) rules were notified by the central

government in 1954. The futures trade in spices was first

organised by the India Pepper and Spices Trade Association

(IPSTA) in Cochin in 1957. However, in order to monitor the

price movements of several agricultural and essential

commodities, futures trade was completely banned by the

government in 1966. Subsequent to the ban of futures trade,

many traders resorted to unofficial and informal trade in

futures. However, in India‘s liberalization epoch as per the

June 1980 Khusro committee‘s recommendations, the

government reintroduced futures on selected commodities,

including cotton, jute, potatoes, etc.

 

Following the introduction of economic reforms in 1991, the

Government of India appointed an expert committee on

forward markets under the chairmanship of Prof. K.N. Kabra

in June 1993. The committee submitted its report in

September 1994, championing the reintroduction of futures,

which were banned in 1966, and expanding its coverage to

55

agricultural commodities, along with silver. In order to boost

the agricultural sector, the National Agricultural Policy 2000

envisaged external and domestic market reforms and

dismantling of all controls and regulations in the agricultural

commodity markets. It also proposed an expansion of the

coverage of futures markets to minimize the wide fluctuations

in commodity prices and for hedging the risk arising from

extreme price volatilities.

 

STRUCTURE, CONDUCT & CURRENT STATUS

 

Broadly, the commodities market exists in two distinct forms—

the over-the-counter (OTC) market and the exchange based

market. Further, as in equities, there exists the spot and the

derivatives segments. Spot markets are essentially OTC

markets and participation is restricted to people who are

involved with that commodity, such as the farmer, processor,

wholesaler, etc. A majority of the derivatives trading takes

56

place through the exchange-based markets with standardized

contracts, settlements, etc. The exchange-based markets are

essentially derivative markets and are similar to equity

derivatives in their working, that is, everything is standardized

and a person can purchase a contract by paying only a

percentage of the contract value. A person can also go short

on these exchanges. Moreover, even though there is a

provision for delivery, most contracts are squared-off before

expiry and are settled in cash. As a result, one can see an

active participation by people who are not associated with the

commodity. The typical structure of commodity futures

markets in India is as follows:

 

At present, there are 26 exchanges operating in India and

carrying out futures trading activities in as many as 146

commodity items. As per the recommendation of the FMC, the

Government of India recognized the National Multi Commodity

Exchange (NMCE), Ahmadabad; Multi Commodity Exchange

(MCX), National Commodity and Derivative Exchange

(NCDEX), Mumbai and Indian Commodity Exchange ( ICEX) as

nation-wide multi-commodity exchanges.

 

As compared to 59 commodities in January 2005, 94

commodities were traded in December 2006 in the commodity

futures market. These commodities included major agricultural

commodities such as rice, wheat, jute, cotton, coffee, major

pulses (such as urad, arahar and chana), edible oilseeds (such

as mustard seed, coconut oil, groundnut oil and sunflower),

57

spices (pepper, chillies, cumin seed and turmeric), metals

(aluminium, tin, nickel and copper), bullion (gold and silver),

crude oil, natural gas and polymers, among others. Gold

accounted for the largest share of trade in terms of value. A

temporary ban was imposed on futures trading in urad and tur

dal in January 2007 to ensure orderly market conditions. An

efficient and well-organised commodities futures market is

generally acknowledged to be helpful in price discovery for

traded commodities.

COMMODITIES TRADED

58

 

World-over one will find that a market exits for almost all the

commodities known to us. These commodities can be broadly

classified into the following:

 

METAL

Aluminium, Copper, Lead, Nickel,

Sponge Iron, Steel Long (Bhavnagar),

Steel Long (Govindgarh), Steel Flat,

Tin, Zinc

BULLIONGold, Gold HNI, Gold M, i-gold,

Silver, Silver HNI, Silver M

FIBERCotton L Staple, Cotton M Staple,

Cotton S Staple, Cotton Yarn, Kapas

ENERGY

Brent Crude Oil, Crude Oil, Furnace

Oil, Natural Gas, M. E. Sour Crude

Oil

SPICESCardamom, Jeera, Pepper, Red Chilli,

Turmeric

PLANTATIONSArecanut, Cashew Kernel, Coffee

(Robusta), Rubber

PULSES Chana, Masur, Yellow Peas

PETROCHEMICAL

SHDPE, Polypropylene(PP), PVC

OIL & OIL SEEDS Castor Oil, Castor Seeds, Coconut

Cake, Coconut Oil, Cotton Seed,

Crude Palm Oil, Groundnut Oil,

KapasiaKhalli, Mustard Oil, Mustard

Seed (Jaipur), Mustard Seed (Sirsa),

RBD Palmolein, Refined Soy Oil,

59

Refined Sunflower Oil, Rice Bran

DOC, Rice Bran Refined Oil, Sesame

Seed, Soymeal, Soy Bean, Soy Seeds

CEREALS Maize

OTHERS

Guargum, Guar Seed, Gurchaku,

Mentha Oil, Potato (Agra), Potato

(Tarkeshwar), Sugar M-30, Sugar S-

30 

 

BENEFITS OF COMMODITY FUTURES MARKETS

 

The primary objectives of any futures exchange are authentic

price discovery and an efficient price risk management. The

beneficiaries include those who trade in the commodities being

offered in the exchange as well as those who have nothing to

do with futures trading. It is because of price discovery and

risk management through the existence of futures exchanges

that a lot of businesses and services are able to function

smoothly.

 

1. Price Discovery:-Based on inputs regarding specific

market information, the demand and supply equilibrium,

weather forecasts, expert views and comments, inflation

rates, Government policies, market dynamics, hopes and

fears, buyers and sellers conduct trading at futures

exchanges. This transforms in to continuous price discovery

mechanism. The execution of trade between buyers and

60

sellers leads to assessment of fair value of a particular

commodity that is immediately disseminated on the trading

terminal.

 

2.    Price Risk Management: - Hedging is the most common

method of price risk management. It is strategy of offering

price risk that is inherent in spot market by taking an equal

but opposite position in the futures market. Futures markets

are used as a mode by hedgers to protect their business from

adverse price  change. This could dent the profitability of their

business. Hedging benefits who are involved in trading of

commodities like farmers, processors, merchandisers,

manufacturers, exporters, importers etc.

 

3.    Import- Export competitiveness: - The exporters can

hedge their price risk and improve their competitiveness by

making use of futures market. A majority of traders which are

involved in physical trade internationally intend to buy

forwards. The purchases made from the physical market might

expose them to the risk of price risk resulting to losses. The

existence of futures market would allow the exporters to

hedge their proposed purchase by temporarily substituting for

actual purchase till the time is ripe to buy in physical market.

In the absence of futures market it will be meticulous, time

consuming and costly physical transactions.

 

4.    Predictable Pricing: - The demand for certain

commodities is highly price elastic. The manufacturers have to

61

ensure that the prices should be stable in order to protect

their market share with the free entry of imports. Futures

contracts will enable predictability in domestic prices. The

manufacturers can, as a result, smooth out the influence of

changes in their input prices very easily. With no futures

market, the manufacturer can be caught between severe short-

term price movements of oils and necessity to maintain price

stability, which could only be possible through sufficient

financial reserves that could otherwise be utilized for making

other profitable investments.

 

5.    Benefits for farmers/Agriculturalists: - Price

instability has a direct bearing on farmers in the absence of

futures market. There would be no need to have large reserves

to cover against unfavorable price fluctuations. This would

reduce the risk premiums associated with the marketing or

processing margins enabling more returns on produce. Storing

more and being more active in the markets. The price

information accessible to the farmers determines the extent to

which traders/processors increase price to them. Since one of

the objectives of futures exchange is to make available these

prices as far as possible, it is very likely to benefit the farmers.

Also, due to the time lag between planning and production, the

market-determined price information disseminated by futures

exchanges would be crucial for their production decisions.

 

6.    Credit accessibility: - The absence of proper risk

management tools would attract the marketing and processing

62

of commodities to high-risk exposure making it  risky business

activity to fund. Even a small movement in prices can eat up a

huge proportion of capital owned by traders, at times making

it virtually impossible to payback the loan. There is a high

degree of reluctance among banks to fund commodity traders,

especially those who do not manage price risks. If in case they

do, the interest rate is likely to be high and terms and

conditions very stringent. This posses a huge obstacle in the

smooth functioning and competition of commodities market.

Hedging, which is possible through futures markets, would cut

down the discount rate in commodity lending.

 

7.    Improved product quality: - The existence of

warehouses for facilitating delivery with grading facilities

along with other related benefits provides a very strong reason

to upgrade and enhance the quality of the commodity to grade

that is acceptable by the exchange. It ensures uniform

standardization of commodity trade, including the terms of

quality standard: the quality certificates that are issued by the

exchange-certified warehouses have the potential to become

the norm for physical trade.

63

Derivatives Market

64

A derivative is a financial product which has been derived from

another financial product or commodity.

D.G. Gardener defined the derivatives as “A derivative is a

financial product which has been derived from market for

another product.”The securities contracts (Regulation) Act

1956 defines “derivative” as under section 2(ac).As per this

“Derivative” includes

(a) “a security derived from a debt instrument, share, loan

whether secured or unsecured, risk instrument or contract for

differences or any other form of security.”

(b) “a contract which derived its value from the price, or index

of prices at underlying securities.”

The above definition conveys that the derivatives are financial

products. Derivative is derived from another financial

instrument/ contract called the underlying. A derivative

derives its value from underlying assets.

Accounting standard SFAS133 defines a derivative as “a

derivative instrument is a financial derivative or other contract

will all three of the following characteristics:

(i) It has (1) one or more underlying, and (2) one or more

notional amount or payments provisions or both. Those terms

determine the amount of the settlement or settlements.

(ii) It requires no initial net investment or an initial net

investment that is smaller than would be required for other

65

types of contract that would be expected to have a similar

response to changes in market factors.

(iii) Its terms require or permit net settlement. It can be

readily settled net by a means outside the contract or

itprovides for delivery of an asset that puts the recipients in a

position not substantially different from net settlement.From

the aforementioned, derivatives refer to securities or to

contracts that derive from another whose value depends on

another contract or assets. As such the financial derivatives

are financial instrument whose prices or values are derived

from the prices of other underlying financial instruments or

financial assets. The underlying instruments may be an equity

share, stock, bond, debenture, treasury bill, foreign currency

or even another derivative asset.Hence, financial derivatives

are financial instruments whose prices are derived from the

prices of other financial instruments.

1. Management of risk : One of the most important services

provided by the derivatives is to control, avoid, shift and

manage efficiently different types of risk throughvarious

strategies like hedging, arbitraging, spreading etc. Derivative

assist the holders to shift or modify suitable the risk

characteristics of the portfolios. These are specifically useful in

highly volatile financial conditions like erratic trading, highly

flexible interest rates, volatile exchange rates and monetary

chaos.

66

2. Measurement of Market: Derivatives serve as the

barometers of the future trends in price which result in the

discovery of new prices both on the spot and future markets.

They help in disseminating different information regarding the

future markets trading of various commodities and securities

to the society which enable to discover or form suitable or

correct or true equilibrium price in the markets. As a result,

they assets in appropriate and superior allocation of resources

in the society.

3. Efficiency in trading: Financial derivatives allow for free

trading of risk components and that leads to improving market

efficiency. Traders can use a position in one or more financial

derivatives as a substitute for a position in underlying

instruments. In many instances, traders find financial

derivatives to be a more attractive instrument than the

underlying security. This is mainly because of the greater

amount of liquidity in the market offered by derivatives as well

as the lower transaction costs associated with trading a

financial derivative as compared to the costs of trading the

underlying instruments in cash market.

4. Speculation and arbitrage : Derivatives can be used to

acquire risk, rather than to hedge against risk. Thus, some

individuals and institutions will enter into a derivative contract

to speculate on the value of the underlying asset, betting that

the party seeking insurance will be wrong about the future

value of the underlying asset. Speculators look to buy an asset

in the future at a low price according to a derivative contract

when the future market price is high, or to sell an asset in the

67

future at a high price according to derivative contract when

the future market price is low. Individual and institutions may

also look for arbitrage opportunities, as when the current

buying price of an asset falls below the price specified in a

futures contract to sell the asset.

5. Price discovery : The important application of financial

derivatives is the price discovery which means revealing

information about future cash market prices through the

future market. Derivative markets provide a mechanism by

which diverse and scattered opinions of future are collected

into one readily discernible number which provides a

consensus of knowledgeable thinking.

6. Hedging : Hedge or mitigate risk in the underlying, by

entering into a derivative contract whose value moves in the

opposite direction to their underlying position and cancels part

or all of it out. Hedging also occurs when an individual or

institution buys an asset and sells it using a future contract.

They have access to the asset for a specified amount of time,

and can then sell it in the future at a specified price according

to the futures contract of course, this allows them the benefit

of holding the asset.

7. Price stabilization function : Derivative market helps to keep

a stabilizing influences on spot prices by reducing the short

term fluctuations. In other words, derivatives reduces both

peak and depths and lends to price stabilization effect in the

cash market for underlying asset.

68

8. Gearing of value : Special care and attention about financial

derivatives provide leverage (or gearing), such that a small

movement in the underlying value can cause a large difference

in the value of the derivative.

9. Develop the complete markets : It is observed that

derivative trading develop the market towards “complete

markets” complete market concept refers to that situation

where no particular investors be better of than others, or

patterns of returns of all additional securities are spanned by

the already existing securities in it, or there is no further scope

of additional security.

10. Encourage competition : The derivatives trading encourage

the competitive trading in the market, different risk taking

preference at market operators like speculators, hedgers,

traders, arbitrageurs etc. resulting in increase in trading

volume in the country. They also attract young investors,

professionals and other experts who will act as catalysts to the

growth of financial market.

11. Liquidity and reduce transaction cost : As we see that in

derivatives trading no immediate full amount of the

transaction is required since most of them are based on

margin trading. As a result, large number of traders,

speculators, arbitrageurs operates in such markets. So,

derivatives trading enhance liquidity and reduce transaction

cost in the markets of underlying assets.

69

Derivative markets in India have been in existence in one form

or the other for a long time. In the area of commodities, the

Bombay Cotton Trade Association started future trading way

back in 1875. This was the first organized futures market.

Then Bombay Cotton Exchange Ltd. in 1893, Gujarat

VyapariMandall in 1900, Calcutta Hesstan Exchange Ltd. in

1919 had started future market.

After the country attained independence, derivative market

came through a full circle from prohibition of all sorts of

derivative trades to their recent reintroduction. In 1952, the

government of India banned cash settlement and options

trading, derivatives trading shifted to informal forwards

markets. In recent years government policy has shifted in

favour of an increased role at market based pricing and less

suspicious derivatives trading. The first step towards

introduction of financial derivatives trading in India was the

promulgation at the securities laws (Amendment) ordinance

1995. It provided for withdrawal at prohibition on options in

securities. The last decade, beginning the year 2000, saw

lifting of ban of futures trading in many commodities. Around

the same period, national electronic commodity exchanges

were also set up. The more detail about evolution of

derivatives are shown in table No.1 with the help of the

70

chronology of the events. This table is presenting complete

historical developments

The NSE and BSE are two major Indian markets have shown a

remarkable growth both in terms of volumes and numbers of

traded contracts. Introduction of derivatives trading in 2000,

in Indian markets was the starting of equity derivative market

which has registered on explosive growth and is expected to

continue the same in the years to come. NSE alone accounts

99% of the derivatives trading in Indian markets. Introduction

of derivatives has been well received by stock market players.

Derivatives trading gained popularity after its introduction in

very short time.If we compare the business growth of NSE and

BSE in terms of number of contracts traded and volumes in all

product categories with the help of table no.4, table no.5 and

table no.12 which shows the NSE traded 636132957 total

contracts whose total turnover is Rs.16807782.22 cr in the

year 2012-13 in futures and options segment while in currency

segment in 483212156 total contracts have traded whose total

turnover is Rs.2655474.26 cr in same year.In case of BSE the

total numbers of contracts traded are 150068157 whose total

turnover is Rs.3884370.96 Cr in the year 2012-13 for all

segments. In the above case we can say that the performance

of BSE is not encouraging both in terms of volumes and

numbers of contracts traded in all product categories. The

table no.4, table no.5 and table no.12 summarily specifies the

updated figures since 2003-04 to 2012-13 about number of

contracts traded and total volumes in all segments

71

1952 - Enactment of the forward contracts (Regulation)

Act.

1953 - Setting up of the forward market commission.

1956- Enactment of SCRA

1969 -Prohibition of all forms of forward trading under

section 16 of SCRA.

1972 -Informal carry forward trades between two

settlement cycles began on BSE.

1980-Khuso Committee recommends reintroduction of

futures in most commodities.

1983- Govt. ammends bye-laws of exchange of Bombay,

Calcutta and Ahmedabad and introduced carry forward

trading in specified shares.

1992 -Enactment of the SEBI Act.

1993 -SEBI Prohibits carry forward transactions.

1994 -Kabra Committee recommends futures trading in 9

commodities.

1995- G.S. Patel Committee recommends revised carry

forward system.

14th Dec. 1995 NSE asked SEBI for permission to trade

index futures

1996 -Revised system restarted on BSE.

18th Nov. 1996- SEBI setup LC Gupta committee to draft

frame work for index futures

11th May 1998- LC Gupta committee submitted report

1st June 1999- Interest rate swaps/forward rate

agreements allowed at BSE

72

7th July 1999- RBI gave permission to OTC for interest

rate swaps/forward rate agreements

24th May 2000 - SIMEX chose Nifty for trading futures

and options on an Indian index

25th May 2000- SEBI gave permission to NSE & BSE to

do index futures trading

9th June 2000-Equity derivatives introduced at BSE

12th June 2000- Commencement of derivatives trading

(index futures) at NSE

31st Aug. 2000-Commencement of trading futures &

options on Nifty at SIMEX

1st June 2001-Index option launched at BSE

Jun 2001- Trading on equity index options at NSE

July 2001 -Trading at stock options at NSE

9th July 2001-Stock options launched at BSE

July 2001 -Commencement of trading in options on

individual securities

1st Nov. 2001-Stock futures launched at BSE

Nov. 2001 -Commencement of trading in futures on

individual security

9th Nov. 2001-Trading of Single stock futures at BSE

June 2003 -Trading of Interest rate futures at NSE

Aug. 2003- Launch of futures & options in CNX IT index

13th Sep. 2004-Weekly options of BSE

June 2005 -Launch of futures & options in Bank Nifty

index

Dec. 2006 '-Derivative Exchange of the Year by Asia risk

magazine

73

June 2007 -NSE launches derivatives on Nifty Junior &

CNX 100

Oct. 2007- NSE launches derivatives on Nifty Midcap -50

1st Jan. 2008-Trading of Chhota (Mini) Sensex at BSE

1st Jan. 2008-Trading of mini index futures & options at

NSE

3rd March 2009-Long term options contracts on S&P

CNX Nifty index

NA Futures & options on sectoral indices ( BSETECK,

BSE FMCG, BSE Metal, BSE Bankex

& BSE oil & gas)

29th Aug. 2008-Trading of currency futures at NSE

Aug. 2008- Launch of interest rate futures

1st Oct. 2008-Currency derivative introduced at BSE

10th Dec. 2008-S&P CNX Defty futures & options at NSE

Aug. 2009- Launch of interest rate futures at NSE

7th Aug. 2009-BSE-USE form alliance to develop

currency & interest rate derivative markets

18th Dec. 2009-BSE's new derivatives rate to lower

transaction costs for all

Feb. 2010- Launch of currency future on additional

currency pairs at NSE

Apr. 2010 -Financial derivatives exchange award of the

year by Asian Banker to NSE

July 2010- Commencement trading of S&P CNX Nifty

futures on CME at NSE

74

Oct. 2010- Introduction of European style stock option at

NSEJournal of Business Management & Social Sciences

Research (JBM&SSR) ISSN No: 2319-5614

Oct. 2010 -Introduction of Currency options on USD INR

by NSE

July 2011- Commencement of 91 day GOI trading Bill

futures by NSE

Aug. 2011 -Launch of derivative on Global Indices at NSE

Sep. 2011- Launch of derivative on CNX PSE & CNX

infrastructure Indices at NSE

30th March 2012-BSE launched trading in BRICSMART

indices derivatives

Insurance Market

75

Indian Insurance Industry has got the deep-rooted history.

These evidences are from the writings of Manu (Manusmrithi),

Yagnavalkya (Dharmasastra) and Kautilya (Arthasastra). The

writings speak about pooling of resources that could be re-

distributed in times of calamities such as fire, floods,

epidemics and famine. Ancient Indian history has preserved

the very earliest traces of insurance in the form of marine

trade loans and carriers contracts. In India the Insurance has

evolved over time heavily drawing from other countries,

England particularly.

In India the advent of Life Insurance started in the year 1818

with the establishment of the Oriental Life Insurance Company

in Calcutta. In the year 1829, the Madras Equitable had began

the life insurance business in the Madras Presidency. British

Insurance Act enactment was done in the year 1870. In the

last three decades of the nineteenth century, the Bombay

Mutual (1871), Oriental (1874) and Empire of India (1897)

76

were started in the Bombay Residency. This era, however, was

dominated by foreign insurance offices which did good

business in India, namely Albert Life Assurance, Royal

Insurance, Liverpool and London Globe Insurance and the

Indian offices were up for hard competition from the foreign

companies.

History of general insurance was during the 17th century to

the Industrial Revolution in the west and the consequent

growth of sea-faring trade and commerce in the 17th century.

The General Insurance has its roots in the year 1850 in

Calcutta from the establishment of Triton Insurance Company

Ltd., by British. The Indian Mercantile Insurance Ltd was set

up in the year 1907. As this was the first company to transact

all classes of general insurance business. In the year 1957

General Insurance Council, a wing of the Insurance

Association of India was established.

With the emergence of growing demand for insurance, more

and more insurance companies are now emerging in the Indian

Insurance Industry. With the opening up of the economy, there

are several international leaders in the insurance of India are

trying to venture into the India insurance industry. In the year

1993, Malhotra Committee was formed which initiated reforms

in the Indian Insurance Industry. The aim of which was to

assess the functionality of the industry. It was incharge of

recommending the future path of insurance in India.It even

attempted to improve various aspects, making them more

appropriate and effective for the Indian market.

77

In the year 1999 The Insurance Regulatory and Development

Authority Act was formulated which brought about several

crucial policy changes in the India. In 2000 it led to the

formation of the Insurance Regulatory and Development

Authority. The goals of IRDA are to safeguard the interests of

insurance policyholders, as well as to initiate different policy

measures to help sustain growth in the industry. This Authority

has notified 27 Regulations on various issues like Registration

of Insurers, Regulation on insurance agents, Re-insurance,

Solvency Margin, Obligation of Insurers to Rural and Social

sector, Investment and Accounting Procedure, Protection of

policy holders' interest, etc.

Indian Insurance Industry is flourishing with several national

and international players competing and growing at rapid

rates. The success comes usually from the easing of policy

regulations, and India has become more familiar with different

insurance products and the period from 2010 - 2015 is

projected to be the 'Golden Age' for the Indian insurance

industry.

Indian Insurance companies today offer a comprehensive

range of insurance plans, a range which is growing as the

economy matures and the wealth of the middle classes

increases. The most common types of insurance includes: term

life policies, endowment policies, joint life policies, whole life

policies, loan cover term assurance policies, unit-linked

insurance plans, group policies, pension plans, and annuities.

Those like the General insurance plans are also available to

78

cover motor insurance, home insurance, travel insurance and

health insurance.

Types of Insurance

1. Life Insurance is all about guaranteeing a specific sum of

money to a designated beneficiary upon the death of the

insured, or to the insured if he or she lives beyond a

certain age.

2. Health Insurance - it is Insurance against expenses

incurred through illness of the insured or the person who

takes up the insurance.

3. Liability Insurance usually insures property such as

automobiles, property and professional/business mishaps

and others.

Latest developments

In November 2009 According to the industry body report

publication, the medical insurance sector would account

for US$ 3 billion in the next three years.

In the year 2008-09 the IRDA in its annual report said

that the Health insurance premium collections touched

US$ 1.45 billion compared with US$ 1.13 billion in the

previous year.

Further in 2009 the total premium between April and

December was US$ 1.35 billion, up from US$ 1.12 billion,

79

an increase of 20 %, as per figures released by the

regulator.

According to IRDA guidance note released by IRDA, the

regulator has increased the lock-in period for all unit-

linked insurance plans (ULIPS) to five years from the

current three years, which makes them long-term

financial instruments and provide risk protection. The

commission and expenses have also been reduced by

evenly distributing them throughout the lock-in period.

In the year 2010-2011 The Indian insurance unit of Dutch

financial services firm ING plans to invest US$ 51 million

to fund expansion in the country. 100 branches will be

opened by Private life insurer Future General India will

expand its distribution network in addition to its existing

network of 91 branches during 2010. There will also be

increase in the agency force by 21,000 to 65,000 people.

In next five year Max Groups to invest a further US$

134.9 Million by Max Buda, the health insurance JV

between UK's Buda. Besides the existing six cities, it

plans to open up into Surat, Jaipur and Ludhiana by the

end of 2010.

The total market size of the insurance sector in India was US$

66.4 billion in FY 13. It is projected to touch US$ 350-400

billion by 2020.

India was ranked 10th among 147 countries in the life

insurance business in FY 13, with a share of 2.03 per cent. The

80

life insurance premium market expanded at a CAGR of 16.6

per cent from US$ 11.5 billion to US$ 53.3 billion during FY

03-13. The non-life insurance premium market also grew at a

CAGR of 15.4 per cent in the same period, from US$ 3.1 billion

to US$ 13.1 billion.

Digital@Insurance-20X By 2020, by Boston Consulting Group

(BCG) and Google India forecasts that insurance sales from

online channels will grow 20 times from present day sales by

2020, and overall internet influenced sales will touch Rs

300,000-400,000 crore (US$ 49.63-66.18 billion).

Investment corpus in India's pension sector is projected to

cross US$ 1 trillion by 2025, following the passage of the

Pension Fund Regulatory and Development Authority (PFRDA)

Act 2013, as per a joint report by CII-EY on Pensions Business

in India.

Government Initiatives

The Union Budget 201 4-15 increased the FDI limit in

insurance to 49 per cent. The increase in the FDI limit could

help the insurance industry in two ways. One, this could help

companies access capital more easily and, two, it could act as

a trigger for listing of insurance players, which will offer a

better benchmark to value these companies.

In a bid to facilitate banks to provide greater choice in

insurance products through their branches, a proposal could

be made which will allow banks to act as corporate agents and

tie up with multiple insurers. A committee established by the

81

Finance Ministry of India is likely to suggest this model as an

alternative to the broking model.

Road Ahead

The future of India's insurance sector looks good, driven by the

country's favourable demographic, greater awareness,

supportive government which enacts policies that improve

business, customer-centric products, and practices that give

businesses the best environment to grow. India's insurable

population is anticipated to touch 75 crore in 2020, with life

expectancy reaching 74 years. Life insurance is projected to

comprise 35 per cent of total savings by the end of this

decade, compared to 26 per cent in 2009-10.

Problems with the Indian Financial Market

The Indian stock markets till date have remained stagnant due

to the rigid economic controls. It was only in 1991, after the

liberalization process that the India securities market

witnessed a flurry of IPOs serially.

82

India embarked on substantial economic liberalization in 1991.

In the field of finance, the major themes were the scaling back

of capital controls and the fostering of a domestic financial

system. This was part of a new framework of embracing

globalization and of giving primacy to market-based

mechanisms for resource allocation. 

From 1991 to 2002, progress was made in four areas,

reflecting the shortcomings that were then evident. First,

capital controls were reduced substantially to give Indian firms

access to foreign capital and to build nongovernment

mechanisms for financing the current account deficit. Second,

a new defined-contribution pension system, the New Pension

System, was set up so that the young population could achieve

significant pension wealth in advance of demographic

transition. Third, a new insurance regulator, the Insurance

Regulation and Development Agency, was set up, and the

public sector monopolies in the field of insurance were broken

to increase access to insurance. Fourth and most important,

there was a significant burst of activity in building the equity

market because of the importance of equity as a mechanism

for financing firms and the recognition of infirmities of the

equity market. This involved establishing a new regulator, the

Securities and Exchanges Board of India, and new

infrastructure institutions, the National Stock Exchange and

the National Securities Depository. The reforms of the equity

market involved ten acts of parliament and one constitutional

amendment, indicative of the close linkage between deeper

economic reforms and legislative change.

83

While all these moves were in the right direction, they were

inadequate. A large number of problems with the financial

system remain unresolved. In cross-country rankings of the

capability of financial systems, India is typically found in the

bottom quartile of countries. A financial system can be judged

on the extent to which it caters to growth, stability, and

inclusion, and the Indian system is deficient on all of those

counts. By misallocating resources, it hampers growth. The

entire financial system suffers from high systemic risk.

The households and firms of India are extremely diverse, and

often have characteristics not seen elsewhere in the world. For

finance to reach a large fraction of firms and households,

financial firms need to energetically modify their products and

processes, and innovate to discover how to serve customers.

But in the field of finance, the forces of competition and

innovation have been blocked by the present policy

framework. This means there are substantial gaps between the

products and processes of the financial system, and the needs

of households and firms.

It is likely that around 2053, India’s GDP will exceed that of

the United States as of 2013. In the coming forty years, India

will need to build up the institutional machinery for markets as

complex as the financial system seen in advanced economies

today. The IFC puts India on that path. 

84

Solutions

By 2004, it was becoming increasingly clear that while some

elements of modernization of the financial system had taken

place from 1992 to 2004, financial economic policy needed to

be rethought on a much larger scale to address the problems

facing the system. As is the convention in India, the consensus

on desired reforms was constructed through reports from four

expert committees on:

1. International finance, led by Percy Mistry in 2007

2. Domestic finance, led by Raghuram Rajan in 2008

3. Capital controls, led by U. K. Sinha in 2010 

4. Consumer protection, led by DhirendraSwarup in 2010

These four reports add up to an internally consistent and

comprehensive framework for Indian financial reforms. The

findings were widely discussed and debated in the public

discourse (see table 1 for the main recommendations of these

expert committees). The four reports diagnosed problems,

proposed solutions, and reshaped the consensus.

85

Primary Data

86

I spoke to close relatives who have had experience with the

financial markets. They have seen the Indian markets

transform from the 1980’s till the current day.

Q. What were the markets like in the 1980’s as compared to

the current day?

A. In the 1980’s there was much less use of technology. The

open outcry was still in existence which made the market

place really chaotic. Now everything is computarised therefore

making trading much more convenient and also removing the

chances of human error.

Q. How has globalization affected the markets?

A. The SEBI has taken many efforts to remove restrections on

foreign players entering the markets. There are less issues

when it comes to FDI’s and FFI’s and thus the Indian forex

market has boomed and it has also made India a very well

recognized economy in the world. Foreign investors realize

that there is no better place to invest as the Indian economy is

on the massive rise and seems that it will continue this trend.

Q. Have you noticed any change in the way investors trade due

to the changes made by the government?

A. The government has introduced many methods via which

companies are required to be more transparent and hence

they have to reveal their financials in a more detailed way.

87

This has helped investors to change their method of analysis

from technical to fundamental thus helping investors make

decisions on number which always proves to be a more

informed decision.

Q. The value of securities traded has obviously gone up from

back in the day. Did you expect such a massive increase in the

volume of trade?

A. To be honest, this increse in trade does not come as a shock

to me because of the various ammendments made in the

different markets. All these changes made have been positive

ones and were designed in a way to increase the value of

securities traded. I would be more taken aback if the volume of

trade had not been as much as it is today.

88

89

90

91

92

93

Conclusion

The Indian Financial System has been in existence for

centuries. From the existence of barter trading to trading with

gold to the current high tech modes of e-finacining and

trading. The current heights that the Indian Fiancial System

has reached have obviously not been attained overnight. As

the popular saying goes “Rome wasn’t built in a day” in the

same way the Indian Financial Markets have gradually

expanded and improved step by step. This project clearly

outlines the strides that have been taken by the government

and the financial instituitions to improve and modernize the

markets. The numbers that have been given in the project are

a clear proof of the positive changes that have been made. If

the trend that has been set in the last 35 years or so continues

in the years to come then truly the sky is the limit for the

Indian economy. The improvement of technology and

enactment of new acts has set the economy in the right

direction and the only direction is upwards. The main markets

that have been covered in the project are :

Capital Markets: Stock markets and Bond markets

Commodity Markets

Money Markets

Derivatives Markets: Futures Markets

Insurance Markets

Foreign Exchange Markets

94

The resesarch methods that I have used also reiterate my faith

in the indian economy. As a youth of the nation I know that

India is headed in the right direction and I can feel safe in this

nation. The above mentioned markets are the main places

where investments take place.

The seeds have been sown years back and with the

introduction of the new government and the imrpovement of

technology and awareness of the investors increasing, our

nation seems destined for economic stability and greatness!

95

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markets.php#ixzz8BoNfOjkd

Equity and corporate debt report: RBI

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