Indian Capital Market

Introduction – Indian Capital Market

The Indian capital market is an integral part of the financial market, the other part being the Money market. The Indian capital market is one of the key engines that drive economic growth. It provides a system for mobilizing funds from investors and channelizing these funds into productive sectors of the economy. The Indian capital market has come a long way since its inception. With the use of technology, trading platforms and regulations have not only become robust but also have become transparent. In this article on Indian Capital Market we will cover all the aspects like evolution, structure, functions, instruments and its overall impact on the Indian economy.

What Is Capital Market

Capital market is a part of the financial market where long term (more than a year) debt and equity backed securities are traded with the view of generating good returns in the long run. This is in contrast to the money market where short term debt instruments are bought and sold. Investors enter capital markets in order to generate reasonable and sometimes phenomenal returns in the long run. Many individual investors like Warren Buffet, George Soros, Rakesh Jhunjhunwala have created a fortune out of capital markets and that too in a legal way. All countries with robust capital markets have regulatory bodies to regulate these markets e.g. SEBI in India, Bank Of England in UK, US Securities and Exchange Commission (SEC) in the USA.

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Historical Evolution Of The Indian Capital Market

The inception of the Indian capital market began in the mid 18th century when stock trading informally began under Banyan trees in Mumbai. By the mid 19th century formal stock exchanges started to emerge in India. In the year 1875, the Bombay Stock Exchange (BSE) was founded which was the first of its kind in Asia. In its initial phase due to lack of industries and big businesses, shares of only textile and trading companies were traded. Thus the history of stock exchanges can be broadly classified into 2 eras namely:

• Pre-Independence Era:
  • Before independence and during British rule, the Indian capital market operated in a limited way as only shares of British companies were traded.  
  • There was no regulatory mechanism which resulted in rampant speculation and price manipulation.
• Post-Independence Era:
  • Post independence measures were taken to develop the Indian Capital market  so that they could develop as one of the engines of growth.  
  • The first law regarding the Indian capital market, The Securities Contracts Regulation Act (SCRA) was enacted in 1956.  With this the  first regulatory framework for securities trading was in place.
  • Later as a part of economic reforms, the National Stock Exchange was started.        
  • A regulatory body the Securities and Exchange Board Of India (SEBI) was established. This replaced the Securities Contracts Regulation Act (SCRA).
  • Two Depositories NSDL and CDSL were started. All brokers have to become participants of these depositories.

Structure of the Indian Capital Market

The Indian capital market can be broadly divided into two primary segments: the primary market and the secondary market.

Primary Market

• When an unlisted company intends to raise capital by selling its equity it has to do this in the Primary market. Thus in the  primary market  companies raise capital by issuing new securities, in the form of  equity shares, debentures, and bonds.
• The first offer to the general public and institutions is done by the Initial Public Offerings (IPOs). This is the first step to raise funds from investors.
• The Securities and Exchange Board of India (SEBI) plays a crucial role in the Indian Capital market as it is instrumental  in overseeing the primary market and ensuring compliance with disclosure norms.
• In many cases investors who bought shares in the primary market and held them for say 15-20 years gained phenomenal returns on investments and became millionaires. They benefited from price appreciations, dividends, bonuses and splits.

Secondary Market

• This is the market  where previously issued securities are bought and sold among investors and traders.
• Earlier there used to be many stock exchanges. Now there are only two major Stock exchanges BSE and NSE. They provide  primary platforms for secondary market trading. Another exchange called MCX is also emerging. As of now this exchange is mostly into commodities trading.
• The secondary market  provides liquidity to investors by allowing them to buy and sell securities at prevailing market prices.

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Indian Capital Market Instruments

Based on the diverse risk profiles and investment objectives of the investors the Indian Capital markets offer a wide range of financial instruments. In this section of Indian capital market we’ll delve into these instruments in a brief and precise manner. Some of the key instruments include:

Equities

 Also called shares or Stocks, equity represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off in the case of liquidation. Thus the share market, stock market and equity market are one and the same thing. 

• When anyone buys shares of a company he becomes a partial owner of that much part of the company.
• A shareholder, since he is a partial owner of the company, is eligible to receive profits in proportion to his shares. 
• This he receives in the form of dividends. A shareholder is also eligible to vote for important decisions made by the company in the Annual General Body meeting.
• Investments in equities can be done in 2 ways: through Primary market (IPO) and through Secondary market.

Fixed-Income Securities

These instruments of the Indian capital market generate fixed returns irrespective of the performance of the price of the share in the secondary market. These can be in the form of Debentures or Bonds.

Debentures

• A debenture is a type of debt instrument that is not backed by any collateral and usually has a term greater than 10 years. 
• This instrument offers businesses and governments a collateral-free way to raise funds without sacrificing share value. Companies with sound finances who do not intend to dilute their equity are allowed to raise funds through this route.
• A debenture is a legal certificate which clearly states how much money the investor paid (Principal amount), the interest to be paid and the schedule of payment.
• During the entire term, every year the interest is paid and the principal amount is paid on maturity.

Bonds

Bonds are purely debt instruments that may be issued by Companies and Government (Central and State). They carry a fixed rate of return which is slightly more than the Fixed Deposits. The bonds also have a lock in period. 

• The Government also borrows in the Indian capital market by means of Dated Securities which have longer tenures usually 3 to 5 years.
• The State governments in India cannot issue Treasury Bills like the Central Government. Thus they borrow through Dated Securities and they are called State Development Loans (SDL)

Derivatives

Derivatives are financial contracts with weekly and monthly expiries. A Derivative is a financial contract that derives its value from an underlying asset such as stocks, commodities, currencies  etc., and is set between two or more parties, where the value of the derivative is derived from price or value fluctuations of the underlying assets. 

• Derivatives are in 2 forms – Futures and Options which allow investors to speculate on the future price movements of underlying assets, such as stocks and indices.
• Derivatives are used for the purpose of hedging, speculating on directional movement of an underlying asset or leveraging a position.
• Most rampant use of derivatives is done for the purpose of trading and making quick money. Very few traders successfully make money in the derivatives market.

Mutual Funds

A mutual fund is a financial instrument run by fund managers which can be a company or an Individual in which money is pooled from investors and invested in stocks, bonds and money market instruments with the view of generating returns in the long run.

• They are beneficial to investors who are unaware of the nitty gritties of the financial markets.
• The fund managers are professionals who allocate funds in accordance with the preferences and risk appetite of the investors.
• Funds are invested in diversified portfolios and are professionally managed so that investors get handsome returns in the long run.
• Mutual Funds are of various types: Index Funds, Sectoral Funds, Balanced Advantage Funds, Mid Cap Funds, Small Cap Funds, Bluechip Funds etc.

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Functions Of Capital Market

• Helps economic growth
• Capital market is the meeting point of those who have surplus funds and those who need funds.
• Better transactional efficiency is achieved by the use of technology.
• The Indian Capital market ensures continuous availability of funds.
• Helps in price regulation and price discovery.
• Capital can be efficiently utilized resulting in increased national income.
• Transaction and information cost can be minimized.
• Provides avenues of investments to investors with varying degrees of risk appetites.
• Risks to Investments can be minimized through hedging.

Regulatory Framework For Indian Capital Markets

In 1992,  The Securities Contracts Regulation Act (SCRA), was done away with and a regulatory body called Securities and Exchange Board of India (SEBI) was established. SEBI is entrusted with overseeing and regulating the capital market. SEBI’s mandate includes ensuring fair and transparent trading practices, protecting investors’ interests, and promoting the development of the market.

Role of SEBI In The Indian Capital Market

• In order to enhance market integrity SEBI has initiated a series of reforms and regulations such as  Know Your Customer (KYC) norms, insider trading regulations, and corporate governance guidelines.
• SEBI constantly monitors and regulates market intermediaries, including stock exchanges, brokers, and mutual funds.
• SEBI has also promoted the adoption of technology in the market, leading to the introduction of online trading and dematerialization of securities.
• Other Regulatory Bodies:
  • The Reserve Bank of India (RBI) plays a significant role in regulating the bond market and managing monetary policy.
  • The Ministry of Finance and the Department of Economic Affairs formulate policies related to capital markets and fiscal measures.

Market Participants and Intermediaries Of The Indian Capital Market

The Indian capital market is composed of a diverse set of participants and intermediaries adding vibrancy to it.

• Investors
  • Retail investors: Individual investors who buy and sell securities for personal investment purposes.
  • Institutional investors: Entities like mutual funds, insurance companies, Domestic Institutional Investors (DIIs) and foreign institutional investors (FIIs) that manage large pools of capital.
• Intermediaries
  • Stockbrokers: Facilitate securities trading on behalf of investors and provide research and advisory services.
  • Depositories: Entities like the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL) facilitate the electronic holding and transfer of securities in dematerialized form. All stock brokers must be participants of either of the 2 depositories.
  • Registrars and Transfer Agents (RTAs): Handle the issuance and transfer of securities, as well as the payment of dividends and interest.
  • Investment bankers: Assist companies in raising capital through methods like IPOs and rights issues.

Recent Developments and Trends In The Indian Capital Market

The Indian capital market has undergone several transformative changes in recent years, driven by technological advancements and regulatory reforms.

• Dematerialization and Online Trading:
  • The shift from physical share certificates to dematerialized form has significantly reduced paperwork and fraud.
  • Online trading platforms have made it easier for investors to access the market from anywhere.
• Algorithmic Trading:
  • The advent of algorithmic trading has increased market efficiency and liquidity.
  • It has also raised concerns about market manipulation and the need for robust risk management.
• Introduction of REITs and InvITs:
  • Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) have provided new investment avenues for retail and institutional investors.
  • These instruments allow investors to participate in the real estate and infrastructure sectors indirectly.
• Financial Inclusion and Investor Education:
  • Initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY) have aimed to bring more individuals into the formal financial sector, including the capital market.
  • Investor education programs have been launched to enhance financial literacy.

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Impact on the Indian Economy

The Indian capital market plays a vital role in shaping the country’s economic landscape in several ways:

Capital Formation:

• It facilitates the mobilization of savings and directs them towards productive investments, thereby fostering economic growth.

Corporate Governance:

• Listing on stock exchanges imposes transparency and accountability requirements on companies, promoting good corporate governance practices. It is mandatory for all listed companies to show quarterly results.

Foreign Investment:

• The Indian capital market attracts foreign institutional investors (FIIs) and foreign direct investment (FDI), contributing to the country’s foreign exchange reserves.

Market Capitalization Growth:

• The capital market’s growth is reflected in the increase in market capitalization, which has witnessed substantial growth over the years.
• As of my last knowledge update in September 2021, India had emerged as one of the largest stock markets globally, with a market capitalization of over USD 3 trillion.
• This growth in market capitalization has a positive wealth effect on the economy, leading to increased consumer spending and economic development.

Employment Generation:

• The capital market ecosystem, including stock exchanges, brokerage firms, mutual funds, and related services, creates employment opportunities for a significant number of people.
• It directly employs professionals such as stockbrokers, fund managers, and financial analysts, while also indirectly supporting ancillary industries.

Infrastructure Development:

• Investment in infrastructure projects, often facilitated through the capital market, is crucial for the country’s economic development.
• Funding for large-scale infrastructure projects, including roads, bridges, airports, and power plants, is often raised through bonds and other debt instruments.

Risk Diversification:

• The capital market allows investors to diversify their portfolios, spreading risk across various asset classes and sectors.
• This risk diversification helps in stabilizing the financial system and reducing the impact of economic downturns.

Challenges and Concerns

Over the years Indian Capital markets have evolved significantly. With the attainment of large size it also faces several challenges and concerns. These can be seen as:

• Volatility:
  • The Indian stock market is known for its volatility, which can make it risky for investors, especially retail investors who may not have the expertise to navigate market fluctuations.
• Lack of Financial Literacy:
  • Despite efforts to improve financial literacy, a significant portion of the Indian population lacks adequate knowledge about investing in the capital market.
  • This can lead to uninformed investment decisions and losses.
• Regulatory Compliance:
  • While regulations have improved, ensuring strict compliance remains a challenge, with instances of corporate fraud and regulatory violations still occurring.
• Market Manipulation:
  • The rise of algorithmic trading and high-frequency trading has raised concerns about market manipulation, prompting the need for robust surveillance and regulation.
• Infrastructure Constraints:
  • The infrastructure supporting the capital market, including trading systems and internet connectivity, needs continuous improvement to cater to the growing investor base.

Future Outlook and Potential Reforms

The Indian capital market’s future appears promising, with several potential reforms and developments on the horizon:

• ESG Integration:
  • The integration of Environmental, Social, and Governance (ESG) criteria into investment decisions is gaining traction, promoting responsible and sustainable investing.
• SME and Start-up Financing:
  • The capital market is likely to see increased participation from small and medium-sized enterprises (SMEs) and start-ups seeking to raise funds for growth.
  • Initiatives like the SME exchange platform will continue to support these endeavors.
• Market Technology:
  • Further advancements in technology, including blockchain and artificial intelligence, can enhance transparency, reduce fraud, and improve the efficiency of the capital market.
• Financial Inclusion:
  • Efforts to promote financial inclusion will continue, bringing more retail investors into the formal financial system.
  • Digital literacy and investor education will be crucial in this regard.
• Regulatory Enhancements:
  • Regulatory bodies like SEBI will continue to adapt to changing market dynamics and introduce measures to enhance market integrity and investor protection.

Indian Capital Market UPSC

From UPSC CSE point of view Capital Market is an important topic. Understanding Indian Capital market is otherwise also important because it is related to Indian economy in a big way. In not in mains, questions are regularly asked in the Prelims.

Conclusion

The Indian capital market is a very important segment of the Indian Financial Market. Over the years it has evolved significantly. Since the Harshad Mehta Scam in the early 1990s, the regulatory framework has been made extremely robust with the help of technology. The Indian Capital market has contributed significantly to the growth story of the Indian economy. However, addressing challenges such as volatility, improving financial literacy, and ensuring regulatory compliance remains imperative to ensure the long-term sustainability and stability of the market. As India continues its journey towards becoming a global economic powerhouse, the capital market will play a pivotal role in shaping its future.

Read Also

Indian Money Market

Anti Defection Law Article

The Controls Affecting The Climate Of India

FAQs

What do you mean by capital market?

Capital market is an avenue for long term investments in Stocks, Bonds, currency and other financial assets. Capital market is a part of financial market, the other part being the Money market.

Who controls Indian capital market?

The Securities and Exchange Board of India (SEBI) is the regulatory authority for Indian Capital Market. But otherwise RBI, Finance Ministry and the Department of Economic Affairs also keep a close watch on the functioning of the Indian Capital Markets.