RELATIONSHIP BETWEEN GROSS DOMESTIC PRODUCT AND DERIVATIVE MARKET OF INDIA

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1 Journal of Management (JOM) Volume 5, Issue 3, May June 2018, pp , Article ID: JOM_05_03_027 Available online at Journal Impact Factor (2016): (Calculated by GISI) ISSN Print: and ISSN Online: IAEME Publication RELATIONSHIP BETWEEN GROSS DOMESTIC PRODUCT AND DERIVATIVE MARKET OF INDIA Sameer Gupta Professor, The Business School, University of Jammu, India Sunil Bhardwaj Assistant Professor, The Business School, Bhaderwah Campus, University of Jammu, India ABSTRACT Last twenty years have exposed the corporate world to many financial risks due to policy of liberalization and globalization policy across the world. In today s dynamic business environment risk management has become very critical for the survival of MNCs. Therefore the emergence of derivative markets in India is attributed to the need of effective and less costly risk management tools for predicting the price of underlying assets. To reduce the extent of financial risks by providing commitment of price of an asset at future date is the basic feature of these financial instruments which had made them popular in the recent times. Trading in derivatives contracts commenced in India from June 2000 and has shown a steep growth in terms of number of contracts traded and volume of trade like market turnover is Rs Cr. in up from Rs.2365 Cr. in Today, the contribution of derivative in the secondary market is approximately 93% of the total value of trade and it has surpassed the trade in cash market within a very short period in terms of turnover and number of contracts traded. This can be attributed to growing GDP of the country which shows a positive correlation with the derivative business of major stock exchanges of the country that is NSE and BSE. Pearson s co-efficient (R-Test) has been used to know how trading activities in derivative markets are correlated to GDP growth of the country. This piece of research tries to give in-depth analysis of Indian derivative markets encompassing historical perspective of derivative trading in India, trends and growth, policies and reforms in Indian derivative market. Key words: Derivatives, Financial Risk, Pearson s Co-efficient, Financial Instrument, Volatility, Derivative. Cite this Article: Sameer Gupta and Sunil Bhardwaj, Relationship Between Gross Domestic Product and Derivative Market of India. Journal of Management, 5(3), 2018, pp editor@iaeme.com

2 Sameer Gupta and Sunil Bhardwaj 1. INTRODUCTION Derivatives are defined as contracts whose value depends upon the value of underlying assets like metal, crude oil or wheat etc. Last twenty years have exposed the corporate world to many financial risks due to the policy of globalization across the world. In today s dynamic business environment risk management has become very critical for the survival of MNCs. Interaction of demand and supply forces in agriculture and non-agriculture commodities in complex business environment brings volatility in price. Therefore the emergence of derivative markets in India is attributed to the need of effective and less costly risk management tools for predicting the price of underlying assets. Financial management always strives to minimize risk and maximize returns on investment to increase the value of firm. Many financial contracts like derivatives which enable risk sharing are used by firms to hedge against the risk of price volatility very efficiently. The emergence of derivative markets in India is attributed to the need of effective and less costly risk management techniques for predicting the price of underlying assets. 2. METHODOLOGY The study is divided into following section. Section-I Historical perspectives and Policies reforms in Indian Derivatives Market Section-II Growth and trends of Indian derivatives markets Section-III Analysis and Conclusion Section II: History and Policy Reforms in Derivatives Markets From the very beginning humans didn t liked the idea of uncertainty and risk and the need to upset this risk and uncertainty gave rise to the idea of contracts. Steve Kummer and Christian Pauletto (2012) proclaimed that the main ideas behind the formation of derivative contracts were to maintain the smooth supply of commodities, to secure farmers against crop failure and to facilitate and promote trade. But today derivatives are used as a source of funding and for making profits besides risk hedging. History of derivatives goes back to 12 th century where they were used as loans for the ships going on expedition and also as insurance for those which were not returning back. According to Ernst Juerg Weber (2008) during 16 th century due to high transportation cost and less speedy communication system derivative contracts in commodities emerged, where standardized price on commodities were fixed for their later delivery. In Indian context, derivative market is believed to have a long history; particularly trading of forward contracts in commodities goes back to the period of Kautilya s Arthashastra. Modern era of future trading in India can be traced back to 1875 when Bombay Cotton Trade Association commenced trading in future contracts. Future trading in commodities like cotton seeds, oil seeds, caster seed and ground nut etc was started by Gujarath Vyapar Mandali in Later on, future exchange for trading wheat contracts was started by chamber of commerce at Harpur in 1913 and future exchange for bullions was established in Mumbai in Similar such exchanges were setup in Calcutta, Jamnagar, Rajkot, Kanpur and Delhi. Shaik Masood and T Satyanarayana Chary (2016) noticed that the East India Jute and Hessin Ltd was established to start organised future trading in raw jute and related items in 1945 which was formed by the merger of Calcutta Hessain Exchange Ltd formed in 1919 and East Indian Jute Association Ltd formed in Government of India put a complete ban on F&O trading in 1966 which was lifted only after the recommendations of Khusro committee in 1980 thus allowing forward trading in only few commodities like Potato, cotton, jute etc. The LPG policy of Indian government has opened new vistas of opportunities in front of derivative trading and government took a leap forward to start Future trading in agriculture commodities like cotton seed, basmati rice, oilseeds etc on editor@iaeme.com

3 Relationship Between Gross Domestic Product and Derivative Market of India the recommendation of Kabra committee in Subsequently, the Securities Laws (Amendment) Ordinance, 1995 was promulgated for the withdrawal of prohibitions on option contracts and for the introduction of trading in financial derivatives. According to Ashutosh and Satish (2010) the decade beginning from the year 2000 showed many good moves on the part of government to develop and promote derivative markets in India like lifting of ban on future trading in most of the commodities and setting up of national electronic commodity exchanges. On the recommendation of L. C Gupta committee derivative trading in India was launched from June 2000 and SEBI permitted derivative trading on BSE and NSE and allowed their clearing houses to undertake trading and settlement in derivatives contracts approved by Securities and Exchange Board of India. To begin with future contracts on stock market indices like S&P CNX Nifty Index futures was started on June 12, 2000, index based options started on June 4, 2000, options on individual securities started on July 2, 2001 and future contracts in single stocks commenced on November 9, 2001 as permitted by SEBI. After the rationalization of Indian derivatives markets in 2003 there is seen a steep increase in the variety of contracts, volume of contracts and total value of turnover on derivative exchanges in India. In 2003 only 53 commodities were permitted for trading in future contracts whereas today future contracts in more than 113 commodities are available. Table 1 Development of Derivatives Market of India in a Chronological Order S.No Date/ Progress of Financial Derivatives Forward (Regulation) Act was enacted Forward Market Commission was set up Securities Contract Regulation Act 1956 was enacted Prohibition on Forward Trading BSE started informal forward trade Futures were introduced based on Khuso Committee Carry forward trading in specific shares commenced SEBI Act was enacted carry forward transactions were prohibited by SEBI future trading in Nine commodities was recommended by Kabra Committee revised carry forward system was recommended by G.S Patel Committee BSE restarted Revised system th Nov LC Gupta Committee was set up th May 1998 L C Gupta Committee submitted its report 15 1 st June 1999 BSE launched forward rate agreements / Interest rate swaps 16 7 st July 1999 OTC for interest rate swaps/forward rate agreements got permission from RBI th May 2000 futures and options on an Indian index were permitted on NSE by SEBI th May 2000 NSE & BSE got permission from SEBI to do index futures trading 19 9 th June 2000 BSE introduced Equity derivatives th June 2000 NSE Commenced derivatives trading (index futures) st Aug 2000 Nifty at SIMEX commenced trading of future & options 22 1 st June 2001 BSE launched Index options 23 June 2001 NSE started Trading on equity index options 24 July 2001 NSE started Trading on stock options 25 9 th July 2001 BSE launched Stock options 26 July 2001 Trading in options on individual securities commenced 27 1 st Nov BSE launched Stock futures 28 Nov 2001 Trading in futures on individual securities started 29 9 th Nov BSE started Trading of single stock future NSE started Trading of interest rate futures and MCX and NCDEX were setup Weekly option of BSE 32 June 2005 future and options in Bank Nifty Index were started Source: Official website of BSE, NSE & MCX editor@iaeme.com

4 Sameer Gupta and Sunil Bhardwaj BSE trading on chotta-sensex (mini) began, F&O on sectoral indices and currency derivatives introduced On NSE Trading of Mini index F&O and currency derivatives were introduced, S&P CNX Defty F&O 35 August 2009 Launch of interest rate future at NSE BSE Launched option on BOLT, Introduction of European style option at NSE NSE started 91 day GOI trading bill futures, derivatives on CNX PSE & CNX infrastructure indices and futures and options on global indices Trading in BRICSMART indices derivatives was launched by BSE &Trading in future and option contracts on FTSE 100 index commenced on NSE th Nov BSE Launched of currency derivative segment (BSE CDX) BSE and NSE Launched interest rate future FMC was merged with the Securities and Exchange Board of India (SEBI). NSE launched nifty 50 index future trading on TAIFEX & Section-II: Growth and Trends of Indian Derivatives Markets Derivative market in India like many other developing economies of the world has witnessed huge growth. In the modern era derivatives trading in India begin in 2000 when two major stock exchanges of the country namely National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) started trading in derivatives. In Indian stock exchanges trading on indices derivative started first followed by trading on commodity derivatives in 2003 and currency derivatives in BSE launched its Equity Derivative (Index future SENSEX) and NSE launched Index future S&P CNX Nifty in Derivative markets in India has registered a steep growth in the recent decade as analysed from the tables below and the same trends seem to be continuing in future. NSE alone accounts for major portion of derivative trading in India. The exponential growth pattern shown by the Indian Derivative Markets is very clear from the table 2 to table 11 as follows: Table 2 Business Growth of all Segments on NSE Total Number of Total Average Daily Table 2 shows the business growth of NSE in terms of number of contracts traded and their total turnover and average daily turnover in respective years. NSE started its business in the year with a total number of contracts with a turnover of rs 2365 cr. Starting from NSE has registered a continuous growth in total number of contracts traded and their respective turnovers. In the year total contracts traded at NSE in all segments editor@iaeme.com

5 Relationship Between Gross Domestic Product and Derivative Market of India were having a turnover of rs cr with average daily turnover of rs cr. Table 3 Average daily transaction in CD & FO Segment at NSE Total Number of F&O Segment Total Average Daily Total No. of CD Segment Total Average Daily Table 3 shows average daily turnover at NSE both in currency derivative and future and option contracts. The table shows an increase in total turnover in both F&O segment as well as in CD segment. The average daily turnover was rs cr and rs cr in for F&O segment and CD segment respectively. The figures have moved to rs cr and rs cr in the year It is found that F&O segment outperform CD segment in terms of total numbers of contract traded, total turnover as well as average daily turnover. Table 4 Number of Contract traded at NSE in CD Segment Currency Futures No. of Currency Options No. of contracts contracts Total No. of contracts From table 4 it is inferred that the total number of contracts in both currency futures and currency option segment show an increase since the inception of CD segment at NSE till But from the growth again picked up which was continue in as well editor@iaeme.com

6 Sameer Gupta and Sunil Bhardwaj Total Number of Table 5 Business Growth in CD Segment of NSE Currency Future (Rs. Cr.) Currency Options Notional Total Average Daily Currency derivatives have a recent history in comparison to index and equity derivatives. Table 5 shows the business growth in currency derivative segment of NSE. The total number of contracts traded in cash derivative segment was in the year whereas the turnover from currency futures and currency options (notional) were almost equal that is rs cr and rs cr respectively. Index Future (Cr.) Table 6 Product wise turnover at NSE Index option Stock Futures Notional Cr.) (Cr.) Stock Option Notional (Cr.) Total (Cr.) Average Daily (Cr.) Product wise analysis from the table 6 shows that there is increase in the turnover in all derivative products traded on NSE. Average daily turnover has increased from rs 410 cr in all products in to rs cr in which is in concurrence with the trends of turnover in all derivative segments editor@iaeme.com

7 Relationship Between Gross Domestic Product and Derivative Market of India Table 7 Number of contracts traded at NSE in FO Segment Index Futures Stock Futures Index Options Stock Options No. Total No. of No. of contracts No. of contracts No. of contracts of contracts contracts In the year only contracts were traded in index future at NSE as trading in stock futures, index options and stock options has not started NSE. In the year the total number of contracts traded at NSE in the above mentioned derivative products were Table 8 Business growth at BSE in all Segments Total Total (Rs Average Daily Trading Cr) (Rs Cr) Days Source: Official website of BSE Table 8 shows the business of BSE in all derivative segments which does not show much encouraging trends. In comparison to NSE the derivative trade at BSE shows less number of contract traded, total turnover and average daily turnover being traded. Moreover there are editor@iaeme.com

8 Sameer Gupta and Sunil Bhardwaj fluctuations in the derivative business of BSE. The stock exchange has registered growth in total number of contracts traded till but was unable to keep the same trends in future. After inception of trading in BSE has witnessed lowest business in the year Table 9 Product wise No. of contracts and traded of futures at BSE Index Futures Equity Futures (Rs Cr.) (Rs Cr.) Source: Official website of BSE As seen from the table 9 there is abrupt fall in the business of index futures and equity futures in the year , and In the year there was no equity future trading BSE and from there after derivative trading at BSE increases till Table 10 Product wise turnover of option at BSE Index option Call (Rs Cr) Index option Put (Rs Cr) Equity option Call (Rs Cr) Index option Put (Rs Cr) Source: Official website of BSE Table 10 shows not much encouraging trends in the option segment of BSE. The turnover for index option call and index option in the year was rs cr and rs editor@iaeme.com

9 Relationship Between Gross Domestic Product and Derivative Market of India cr respectively which was highest in the last decade. From the year to these derivative products have not shown very good business and as such no prominent trends can be noticed. Table 11 Product wise no. of at BSE Index Options Call Index Options Put Equity Options Call Equity Options Put Source: Official website of BSE The results of table 11 are in consistence with the results of table 10. Starting from to till the derivative business in index option and equity option segment at NSE was insignificant. Even in trading in equity option call contracts and equity options put options contracts were nil. It can easily be inferred from above discussion that the derivative business at NSE is far ahead of derivative business of BSE. Section III: Analysis and Conclusion Now, it is clear that derivative market has witness a robust growth in the last decade which is due to increasing gross domestic product of the country which has a perfect positive correlation with the per capita income of firms and individuals. Thus increasing demand for more innovative investments and hedging techniques. When we tried to prove it statistically we found that total number of contracts traded at NSE and BSE have very high positive correlation which is and with the total turnover of derivative trading in NSE and BSE respectively. This means that increase in the number of contracts in these exchanges have also lead to the increase in market capitalization of derivative contracts. We also tried to find out the correlation between the GDP and total turnover at NSE and BSE. We found that, Correlation between total turnover at NSE and GDP is found to be very high that is whereas correlation between total turnover at BSE and GDP is positive but moderate that is This predicts that with the increase in GDP of the country, trading of derivative contracts increases more at NSE in comparison to BSE. The analysis from the above tables also suggest the same thus making NSE as market leader in derivative trading in India. The performance of derivative trading at BSE is less encouraging in comparison to BSE on many vital parameters of derivative trading in India editor@iaeme.com

10 Sameer Gupta and Sunil Bhardwaj Table A showing Correlation Co-efficient of different variables Variables Correlation Co-efficient Total No. of contracts at NSE Total at NSE Total No. of contracts at BSE Total at BSE Total at NSE Gross Domestic Product Total at BSE Gross Domestic Product Derivatives are very well received by the investors and have earned their deserving reputation among all the financial products in the Indian capital market due to innovation and revolutionized landscape. In commodity derivative trading main part is played by MCX and NCDEX. Today, India has six national derivatives exchanges and fifteen regional level derivative exchanges which have registered an exponential growth in terms of value and volume of commodities being trade on these exchanges. Shaik Masood and T Satyanarayana Chary (2016) noticed that in the year the value of derivative trade was rs bn which grew up to rs bn in the year The recent trends of growth in the Indian derivatives markets can also be attribute to strong regulatory framework of Indian financial markets and the latest merger of Forward Market Commission (FMC) with Security and Exchange Board of India (SEBI) to further boost the investors confidence and sentiments in the market. The growth of derivatives in the recent times has surpassed the growth of equity segment in major stock exchanges of India. The country has one of the most matured and vibrant exchange traded derivative markets among developing countries of the world. Country shows very encouraging growth pattern in derivative market with respect to number of contracts, variety of contracts and total turnover of contracts traded which can be compared with the derivative market of many developed countries of the world. Chart A: Showing GDP Growing and Simultaneous Increase in the of Derivative Trading on NSE & BSE In India not only GDP growth but also volatility in financial asset price, innovations in financial engineering, integration of financial markets internationally, sophisticated risk management tools, safe and secure electronic trading and the choices of risk management tools have been driving the growth of financial derivative market editor@iaeme.com

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