Significant Recent Developments In Stock Market Investing in India

Transcription

1 Chapter 5 Significant Recent Developments In Stock Market Investing in India The Indian stock market has undergone major transformation in recent years. It has witnessed a lot of new developments in various spheres of its activities and operations. This chapter attempts to make an assessment of these new developments. Its main emphasis will be on examining how these developments have altered the stock market investing scenario in the country. In the preceding chapter, we have made an assessment of the reform initiatives undertaken in the past two decades to modernize the Indian stock market. These reform initiatives have been instrumental in bringing about major structural changes in stock market operations in India. The trading platform has become automatic, electronic, and nation-wide screen based. Thousands of market participants are now trading with one another anonymously and simultaneously. Everyone now has equal opportunity to access information. There is now greater transparency in the spheres of dissemination of information, price, and quantum of the order. Market regulators have been made more vigilant, and investor protection measures have become more extensive. Another important development that has significantly boosted the Indian stock market is the opening up of the market to foreign investors. All these have helped the Indian stock market to grow. But problems still persist in many areas. The present chapter is divided into four sections. Section 1 examines the major factors that have contributed to the creation of the conditions necessary to develop a proinvestment climate in the country. It begins by narrating how the SEBI has been able to establish itself as the chief market regulator and the nature and significance of the various regulatory roles that it is now performing. The section then proceeds to narrate other key issues such as primary market reforms, modernization of stock exchanges and stock exchange trading mechanisms, introduction of derivatives trading, reconstruction of the mutual fund industry, and creation of opportunities for Fils to invest in Indian stock market, and integration of the foreign exchange market in India with the Indian 123

2 stock market. Section 2 investigates the impact of the above-mentioned measures on stock market investing. It examines separately the impact on institutional investing and non-institutional investing. In Section 3, we focus attention on an analysis of some key stock market development indicators. It analyzes how the stock market reforms undertaken during the period under investigation have impacted the development indicators such as market capitalization, trading volume, and return volatility. The section also makes a comparative analysis of the Indian stock market and other leading stock markets of the world. Concluding remarks are presented in Section Major Factors Responsible for Bringing about Improvement in the Stock Market Investment Climate in India in the Post- Liberalization Period Stock market investing in India has taken a positive route since capital market reforms were initiated since early 90s. Many factors/ reforms have worked together towards providing a better environment for stock market investing in India. According to UNCTAD s World Investment Report, 2012, India is considered to be the third most favored destination for investment by foreign institutional investors (Fils) after China and US for major global companies. At the same time domestic institutional investors also registered a rise since liberalization. In this section, an overview of factors that are known to have worked best towards building a better environment for investing in Indian stock markets from an investor s perspective are discussed The Emergence of the SEBI as Market Regulator The Securities and Exchange Board of India (SEBI) is now the principal market regulator in India. It takes the overall responsibility for the development, regulation, and supervision of the stock market in the country. Although the SEBI was established in 1988, it was in 1992 that the body was given independent authority to regulate the market. The SEBI Act, 1992 provided the necessary legal power. Among other things, the SEBI has been mandated to create an environment which will facilitate mobilization of adequate resources through the securities market and its efficient allocation (Misra and Puri, 2010). 124

3 The overall responsibility of development of the stock market rests with the Securities & Exchange Board of India (SEBI), which was formed in 1992 as an independent authority. Since then, SEBI has consistently tried to lay down market rules in line with the best market practices. It enjoys vast powers of imposing penalties on market participants, in case of a breach. It could be said that with the establishment of the SEBI, the investment climate has improved in India. Strengthening of regulations and improved transparency has resulted in to the development and growth of Indian securities market. It led to a successful transition from a highly controlled merit-based regulatory regime to a market- oriented disclosure based regulatory regime. Constitution and Organization of SEBI The SEBI has been constituted as a body corporate. It consists of a chairman appointed by the Government, two members from amongst officials of the Ministry of Government of India dealing with Finance and administration of the companies appointed by the Government, one member from amongst the officials of, and nominated by the RBI, five members of whom at least two should be whole time members nominated by the government. Its general superintendence, direction and management are vested in Board of members which may exercise all powers and do all acts/ things which may be exercised/ done by the SEBI. SEBI activities are organized into five operational departments, each of which is headed by an executive director, who reports to the chairman. Besides, there is a legal department and the investigation department. The five operational departments are as follows: i. The Primary Market Policy, Intermediaries, Self- Regulatory organizations (SROs) and Investor Grievance and Guidance Department. ii. The Issue management and Intermediaries Department iii. The Secondary Market Policy, Operations and Exchange Administration, New Investment Products and Insider Trading Department. iv. The Secondary Market Exchange Administration, Inspection and Non-member Intermediaries Department. 125

4 v. Institutional Investment (Mutual Funds and Foreign Institutional Investment), Mergers and Acquisitions, Research and Publication and IOSCO (International Organization of Securities Commission) Department (Bhole, 1999). Apart from above, the legal department takes care of all legal matters under the supervision of the general counsel. Under the supervision of the Chief of investigation, investigation department carries out investigation and inspection. Major Functions of the SEBI The major responsibilities entrusted on the SEBI were as follows: 1. To protect the interests of investors in securities 2. Promote the development of the securities market, and 3. Regulate the securities market The scope of operations of the SEBI is very wide; it can frame or issue rules, regulations, directives, guidelines, norms in respect of both the primary and secondary markets, intermediaries operating in the market. It has powers to regulate depositories and participants, custodians, debenture trustees, and trust deeds, Fils, insider trading, merchant bankers, mutual funds, portfolio managers and investment advisors, registrar to issue and share transfer agents, stock brokers and sub brokers, substantial acquisition of shares and takeovers, underwriters, venture capital funds and bankers to issue (Bhole, 2007). Apart from above, SEBI has been vested most of the functions and powers under the Securities Contract Regulation Act, which brought stock exchanges, their members, as well as contracts in securities which could be traded under the regulations of the Ministry of Finance. It has also been delegated certain powers under the Companies Act. In addition to registering and regulating intermediaries, service providers, mutual funds, collective investment schemes, venture capital funds and takeovers, SEBI is also vested with the power to issue directives to any person(s) related to the securities market or to companies in areas of issue of capital, transfer of securities and disclosures. It also has powers to inspect books and records, suspend registered entities and 126

5 cancel registration. The SEBI from time to time have adopted many rules and regulations to foster the growth of Indian capital market. Role of SEBI in Protecting Investors SEBI has taken number of measures to protect the interest of investors viz. issuing fortnightly press releases publishing name of companies against whom maximum number of complaints have been received. This is to create awareness among issuers and intermediaries of the need to redress investor grievance quickly. A representative of SEBI supervises allotment process to eliminate any malpractice during allotment of shares. It issues advertisement from time to time to guide and aware investor on various issues relating to stock market and also their rights and remedies. SEBI has mechanism to facilitate redressal of grievances against intermediaries registered by it and against companies whose securities are listed or proposed to be listed on stock exchange. SEBI also issued guidelines for disclosure and investor protection which the issuers have not to confirm for raising capital from the market. The investor protection issue will be examined in in details in a separate chapter. Role of the SEBI as Regulator of Securities Market The SEBI has been performing its role as regulator of securities market since its inception. The major achievements in this regard can be summarized as follows: The primary market allows corporates to raise funds via initial issues. Therefore, the cost and time taken in such procedure is of utmost importance for these companies. With introduction of new features in primary market viz. introduction of book building route for public issue( discussed in details later in this chapter), margining and proportional allotment for all categories of investors in book built issue, mandatory IPO trading, Qualified Institutions Placement (QIPs), fast track issue, Application Supported by 127

6 Blocked Accounts (ASBA), the SEBI has managed to enhance the efficiency and optimize cost of raising capital from primary market. The Capital Market regulator (SEBI) continues with its effort to widen and deepen the Indian market and take appropriate regulatory measures to make them resilient enough to withstand volatility1. The transaction cost charged by depositories is the lowest in the world. Broking fees have plummeted in the past decade and a half. The maximum brokerage charged by trading member in respect of trades in the equity cash segment can be upto 2.5 percent of the contract price, inclusive of statutory levies like securities transaction tax, the SEBI turnover fee, service tax and stamp duty. However, actual brokerage charged is as low as 0.10 percent suggesting a competitive brokerage industry. Entry load has been abolished for mutual fund. With the introduction of hook building process and mandatory of necessary disclosures in the offer documents, the process of price discovery in the primary market became more transparent. Such transparency was experienced in the secondary market too with the introduction of screen based trading. With the innovation of electronic trading, SEBI could give all information on its website including consent orders, quasi-judicial orders and board notes. Again, internet- based order entry was allowed for execution of trades on stock exchanges. It is said that SEBI has brought about a transition from a highly controlled merit-based regulatory regime to a market oriented disclosure-based regulatory regime. Companies who want to list their securities, listed companies or any regulatory entities, wishing to raise capital from securities market are required to issue all material information in order to facilitate informed decision. It would be noteworthy to mention that with the introduction of T+2 settlement cycle, stock market investing scenario has changed. Initially, it was introduced as T+5 rolling settlement on voluntary basis in 1998 was later made compulsory for any scrip traded on any stock exchange in India in The settlement cycle was further reduced from T+5 to T+2 in

7 Integrated Market Surveillance System (IMSS) is used by SEBI to detect unusual market movements. It also monitors activities of market participants. It is used to issue instructions to stock exchanges and market participants. SEBI regulates the activities of stock exchanges. It also carries out inspection in the surveillance department of the major stock exchanges. Through an efficient risk management system, SEBI tries to address various risks like market risk, operational risk and systematic risk. To mitigate these risks and enhance investor protection, SEBI has been continuously reviewing its policies and drafting risk management policies. In accordance with the recommendation with Financial Action Task Force (FATF) on money laundering, SEBI has introduced KYC (know your customer) regime. SEBI encourages corporatization of brokerage industry and also reviews eligibility norms of intermediaries from time to time. SEBI has laid emphasis on corporate governance issues and made efforts to improve corporate governance environment in India (discussed in chapter 6) Development of Primary Market and Introduction of the Book Building Process. The primary market plays an important role in securities market by acting as a link between savings and investment. It allows government and corporates to issue securities in which investors disburse their savings. The major reform in the primary market was undertaken by abolishing Capital Issues Control Act (already discussed in previous chapter) has brought about significant growth in Primary Market. This was evident from the fact that the total amount of Rs billion was raised from the primary market during (Source: SEBI). If we observe the trend of total issues and resources mobilized over the years starting from , it could be concluded that during early 129

8 years of post-reform period the number of issues in the primary market was much high but the total amount mobilized was not so impressive. Gradually, from , it could be observed that though the total issues remained low during this period but the total amount mobilized increased significantly. The only exception in this case was year when US market crashed due to subprime crisis. In this year, the amount mobilized was Rs billion against the total issue 47. Fig.5.1: Resource Mobilized from Primary Market (Rs in Cr) Resource Mobilized From Primary Market (Rupee in Crore) o 8 o ' Q o ' o ' o ' o o o oo r*. to in f n N h ui Source: Handbook of Indian Statistics, RBI One of the important reforms in the Indian capital market is the introduction of issuing shares through book building process which aims at efficient price discovery. The key difference between book-building and other IPO methods is that the book-building method gives underwriters control over the allocation of shares whereas others do not. Bookbuilding dominates the IPO pricing mechanisms because it results in higher net proceeds, enables smaller and riskier firms to access public equity markets, enables issuers to raise larger amounts of capital, provides liquidity for early investors, places shares with preferred types of investors, 130

9 and encourages underwriters to provide important aftermarket services, although book-building is widely believed to be an expensive process compared to other alternatives. However, only cost differences between book-building and other approaches are not sufficient to outweigh the benefits investors perceive (Islam et al., 2006). The book building process in the system of Initial Public Offering (IPOs) was recognized by SEBI in October, 1995 after recommendation of Committee under the chairmanship of Y.H. Malegam (Saha et al., 2006). Book building is a process of price sighting. The issuer discloses a price band or floor price before opening of the issue of the securities offered. On the basis of the demands received at various price levels within the price band specified by the issuer, Book Running Lead Manager (BRLM) in close consultation with the issuer arrives at a price at which the security offered by the issuer, can be issued. In the book building procedure, an investment banker solicits bids for shares from institutional investors prior to pricing an equity issue. The banker then prices the issue and allocates shares at his discretion to the investors (Comelli et al., 2001). In consequence to book building method, the Green Shoe Option was introduced in the Indian capital market. It is an option of allocating shares in excess of the shares included in the public issue. It is expected to boost investors confidence by arresting the speculative forces which work immediately after the listing and thus results in short-term volatility in post listing price. 5J3Modernization of Stock Exchanges in India Introduction of Screen-based Trading and Dematerialization of Shares The Indian stock market witnessed remarkable transition from an open out-cry System of trading to screen based trading. With the invention of new technology with the establishment of National Stock Exchange, the investors in securities market had privilege of electronic, screen based, order driven trading in securities. With the introduction of screen based trading, the market proved to be more fair and transparent With adoption of V-SAT technology the market became 131

10 accessible to each even in the remote comers of the country. NSE was first to use satellite based communication technology for establishing connectivity. NSE and BSE now offer access from 209 and 359 cities and towns in India respectively. Securities are no longer dealt in physical form, they are dematerialized and electronically recorded to facilitate easy trading and transfer of ownership. All trades on exchanges have to undergo the regulated trading, clearing and settlement processes. The clearing House of Exchange or its subsidiary clearing corporation undertake its post trading activities like clearing and settlement of trades on exchanges. These clearing Houses/ Corporations act as counterparty to trade on exchanges and also guarantees finality of settlement with the help of Settlement Guarantee Fund/Trade Guarantee Fund (TDF). There was a phased transition from accounting period trading settlement to rolling settlement beginning on 10th Jan, 2000 in selected scrips to rolling settlement in all listed scrips from 31st Dec, The settlement cycle was reduced from T+5 to T+2 rolling settlement by 1st April, Again, the problems of delays, bad deliveries, malpractices in share certificates diminished with the introduction of dematerialization i.e. automation of share ownership records in a central database. NSDL3 and CDSL4 are the two main depositories who work with modem infrastructure and nationwide network to handle the securities deposited or settled in dematerialized mode in the Indian Stock market. By the end of March 2011, the number of companies connected to NSDL and CDSL were 8842 and 8152 respectively. The number of dematerialized securities increased from billion at the end of March, 2010 to billion at the end of March, Since the introduction of depository system, dematerialization has progressed at a fast pace and gained acceptance among the participants (ISMR, 2011). With the use of modem technology, screen based trading is now available through internet which has made trading in stock market available remotely to all investors. Now a days trading in stock market is possible even through mobiles. 132

11 Trading Mechanism of Stock Exchanges in India All stock exchanges in India today work on T+25 days settlement cycle. The working hours of the stock exchanges are from 9.00 A.M. to 3.30 P.M. During this period shares listed on stock exchanges can be bought or sold. Any person desirous of trading in stock market has to open a D-Mat account through which securities will be delivered or received. This account may be opened with any of the Depository Participant (DP) which is a SEBI registered intermediary. The SEBI has made it mandatory that any transaction i.e. buying or selling of shares would take place on the stock exchange only through registered brokers or sub-brokers. If a person buys shares his D-Mat account will be credited. Again when a person sells shares, he has to transfer the shares to brokers account through his Demat. Trading of shares also takes place over phone, where brokers identify their clients through a unique client code assigned to them. When the transaction is over, the broker issues a contract note to his client containing details of the transaction. Along with the purchase price of the security, the client is required to pay brokerage, stamp duty and securities transaction tax. Settlement of securities is done through a clearing corporation. Clearing corporation identifies the payable or receivable position of these brokers on the basis of which obligation report of these brokers are created. On T+2 days ail transaction are cleared with the help of fully automated set up depository i.e. NSDL and CDSL Development of Derivative Markets One of the most noteworthy achievements of Indian Capital Market is the development of Derivative Market. The formation of derivative market cannot be said to be recent as they have been in existence in some form or other since long time. In 1875, the Bombay Cotton Trade Association started futures trading in commodities. In equity market, a system of trading called Badla involving some elements of forward trading had been in existence for decades6. The system existed till the Securities and Exchange Board of India banned die system in With the establishment of National Stock Exchange of India in 1993, this offered more transparency in trading with its new technology. The government lifted prohibition on trading options. In response to report by L.C. Gupta Committee who suggested phased introduction of derivative products and bi-level regulation also followed by another report from J.R. Varma Committee 133

12 who worked out various operational details like margining systems. Trading on derivatives now considered to be legal and valid provided they are traded on stock exchanges. Finally, a 30-year ban on forward trading was also lifted in With the introduction of derivatives trading, the markets have become more sophisticated and matured. In India, derivatives trading began in June 2000, with trading in stock index futures. By the end of 2001, both NSE and BSE had four equity derivative products: futures and options for single stock and futures and options for their respective stock indices. By the end of June, 2007, NSE has become largest exchange in single stock futures in the world and 4th globally in trading index futures in the world. In terms of the number of single stock futures contracts traded in 2010, the NSE held the second position. It was second in terms of the number of stock index options contracts traded and third in terms of the number of stock index futures contracts traded in India s experience with equity derivatives market has been extremely positive. The derivatives turnover on the NSE has surpassed the equity market turnover. The turnover of derivatives on the NSE increased from Rs. 23,654 million in to Rs. 292,482,211 million in The introduction of derivative trading has also helped in improving market liquidity. The developments in Indian Securities market like electronic trading; nationwide market access and a predominant retail market have all contributed towards a growing market for exchange traded derivatives in the country (ISMR, 2011). The National Stock Exchange of India (NSE) has maximum market share in the total turnover of derivative markets in the country. The Future and Option trading system of the NSE, called the NEAT-F&O trading system, provides a fully automated, screen-based, anonymous order driven trading system for derivatives on a nationwide basis, and an online monitoring and surveillance mechanism. 134

13 Fig. 5.2: Number of Contracts Traded in NSE-Derivative Market from to Number of Contracts Traded (numbers in crs) in NSE-Derivative Market in oast five vears Index Futures Stock Futures index Option Stock Option Source: NSE Fact Book, 2012, Chapter 6, Table 6.1 Fig. 5.3: Trading Volume of Derivative Market of NSE from to Trading Volume of derivative market in NSE in Past five years (Rs in Crores) 25,000, ,000, ,000, ,000, ,000, Index Futures Stock Futures Index Option Stock Option Source: NSE Fact Book, 2012, Chapter 6, Table

14 5.15Expansion of the Mutual Fund Industry Mutual funds provide opportunity for increasing participation of small investors in financial markets by pooling their funds together. It also helps in inclusion and efficient functioning of markets. Since mutual funds are tide institutional investors, they can invest in market with due and proper analysis which is not available to individual investors, thereby providing services to small investors based on informed decisions. The concept of mutual funds in India is not recent; it has its root in 1964 with the formation of Unit Trust of India (UTI) which functions with the dual objective of mobilizing household savings and investing the funds in the capital market for industrial growth. Household sector accounted for about 80 percent of nation s savings and only about one third of such savings was available to the corporate sector, it was felt that UTI could be an effective vehicle for channelizing progressively larger shares of household savings to productive investments in the corporate sector (Tripathy, 1996). In the period between 1963 and 1988, when UTI was the only player in the industry, the asset under management grew to about Rs. 67 billion (Ray et. al., 2011). In the early 1990s, the government allowed public sector banks and institutions to set up mutual funds. To protect the interests of the investors, SEBI first notified regulations for mutual funds in At a later stage mutual funds sponsored by private sector entities were allowed to enter the market. The number of mutual funds has increased over the period. Today the number has reached to 48. The mutual fund industry in India has grown fast in the recent period. The performance is encouraging especially because the emphasis in India has been on individual investors rather in contrast to advanced countries where mutual funds depend largely on institutional investors. Product innovation undertaken by a highly competitive mutual fund industry has offered more than 3, 000 schemes to meet the diverse investment needs of investors. Resource mobilization by mutual funds has grown at a steady pace over the years. However, during , as a result of the financial crisis, there was a net outflow of funds from the mutual funds industry. Mutual funds like index fund, gold fund etc. have now started trading in Stock Exchange. 136

15 Entry of Foreign Institutional Investment in the Indian Mutual Fund Market The Government of India issued guidelines in Sept, 1992 which enabled foreign institutional investors including institutions such as pension funds, investment trusts, asset management companies, nominee companies, and incorporated/ institutional portfolio managers to make portfolio investment in all securities of listed and unlisted companies in India including the units of Mutual Fund. Table 5.1: Assets under Management of Mutual Funds Year (end-march) Amount (Rs in Cr.) , , ,07, , ,00, ,09, ,39, ,49, ,31, ,26, ,05, ,17, ,13, ,92, ,87, * 8,13,530 Note: * indicates as on last trading day of Feb, Source: SEBI Bulletin, March 2013(vol. 11, No. 3, p.372) and SEBI: Handbook of Indian Securities Market, 2011 (Table 26, p.50) Assets Under Management (AUM) grew nearly ten-fold from Rs.43, 000 crore (US$ 14billion) in June 1993 to Rs.4,00,842 crore (nearly US$ 100 billion) on June 30, The number of mutual fund schemes went up from less than 100 to 772 over the same period (AMFI). The Association of Mutual Funds in India (AMFI) has contributed significantly towards growth of mutual fund industry. Comprising of 32 trade asset management companies, this trade association fund helps develop and maintain high professional and ethical standards in mutual 137

16 fund operations. From the above table it is clear that Asset under Mutual Funds have been showing an increasing trend over the years. Globally, mutual fond assets more than doubled between , while the BRIC nations (Brazil, Russia, China, and India) saw tenfold growth. Following the global financial crisis in mutual fund assets reduced by 12% worldwide, while the BRICs saw an 18% increase. Brazil, China, and India are also set for spectacular future growth in retail mutual funds Opening up of Indian Economy to Foreign Institutional Investors India s development strategy focused on self-reliance and import substitution till 1980s. After the launch of the reforms in the early 1990s, there was a gradual shift towards capital account convertibility. From September 14, 1992, Fils and overseas corporate bodies (OCBs) were permitted to invest in financial instruments, with suitable restrictions.10 With the Foreign Exchange Management Act (FEMA), 1999 coming into force in 2000, the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 were issued to provide the foreign exchange control context where foreign exchange-related transactions of FUs were permitted by the RBI (ISMR, 2011). Fils have been permitted to invest in all types of securities, including government securities, and can freely repatriate the proceeds from the sale of their investments. Taken together they can invest in a company under the portfolio investment route up to 24 per cent of the paid-up capital of the company. This can be increased up to the sectorial cap/statutory ceiling, as applicable, provided this has the approval of the Indian company's Board of Directors and also its general body. Foreign Institutional Investment (FII) flows to India have steadily grown in size and importance over the years. Fils supplement the domestic investments in the country s capital market Further, Fils also helps in achieving a high degree of liquidity in stock markets. Though, Fils usually concentrate on secondary markets, they also help the competent firms to price their new issues at a reasonable premium (Mohanasundaram et al., 2012). 138

17 Foreign Institutional Investors is defined as an institution organized outside India for the purpose of making investments into the Indian securities market under the regulations prescribed by SEBI. All Fils are required to register with SEBI. As on March 2012, the total number of registered Fils in India was 1,765 and total number of registered sub-account is 6322 with a net cumulative investment of US$ Million11. The trend in investing pattern of FH and their impact on Indian stock market have been discussed in the next section. In the year 2012, in its major policy decision, the government allowed Foreign Individual Investor to invest directly in Indian equity market. A QFI is an individual, group or association resident in a foreign country that is compliant with financial action task force (FATF) standards. QFIs do not include Fils/ sub-accounts Integration of Foreign Exchange Market with Stock Market in India With the opening of Indian stock market for foreign Investor since liberalization, Stock market is more integrated with foreign exchange. The Equity Market can impact currency market in many different ways and also it can be applied vice versa as Currency market also has an impact on equity market. When the Equity market is strong or when there is strong rally in the stock exchange, foreign investors also tries to get a share of the rally and thereby invest in stock market by bringing foreign currency (mostly USD) in to the country. The influx of foreign money become very positive for the currency market, as foreign investor sell foreign currency to buy Indian currency, making Indian rupee strong against foreign currency. The opposite also hold correct when the equity market is performing poor, foreign investor will like to sell their investment and likewise, buy foreign currency by selling rupee, which makes rupee weak. This can also be applied vice versa: when currency market also impacts stock market, as when due to some domestic factors, the currency is temporary weak, foreign investor would like to invest in stock market, with a view to make double gain in the stock market The original gain in 139

18 the stock market came from profit in stock market, they make extra gain when Indian currency become strong against foreign market, thereby when they sell their investment, they make extra gain from currency fluctuation / appreciation. The same can be applied vice versa as well Impact of Reforms on Stock Market Investors and Stock Market Investing in India All factors as mentioned above have contributed in building a strong foundation for Indian stock market since economic liberalization. Therefore, Indian stock market has succeeded in attracting both domestic and foreign investors from time to time. In this section we would analyze how stock market investing has changed over the period. For these purpose investors has first been classified under two broad categories: 1. Institutional investors 2. Non- institutional investors The institutional investors can again be classified as Foreign Institutional Investors (Fils) and Domestic Institutional Investors (Dlls), whereas non-institutional investors include individual investors (retail and non-retail), body corporates and others. Foreign institutional investors have already been discussed in the previous section. Here we would analyze how FH investments have changed over the years and its impact on Indian stock market In the graph hereunder, growth of FH investment from till (Feb 13) is shown in the gap of five years. Figures are stated as INR (in Crores). The number of Fils gradually increased from to as shown in fig From the year onwards, the market witnessed a sharp increase in number of Fils. But the number remained almost stagnant in the to Again, FII Investment has also shown the same trend which has increased from Rs 13 Crores in to Rs 6,18,629 Crores in the year

19 Fig 5.4: Growth of Foreign Institutional Investments from till Years Source: SEBI, Handbook of Statistics 2011 Fig 5.5: Number of Registered Foreign Institutional Investors from till Number of Registered Fll 1756 Years Number of Registered Fll 1800 Source: SEBI, Handbook of Statistics

20 Fils have played a significant role in providing liquidity to the Indian securities markets. The FII investment quota in corporate and government debt was increased over time. As of March, 2012, Fils invested US$ million in debt Impact of Foreign Institutional Investors on Indian Stock Market As per previous statistics, it could be clearly understood that foreign institutional investors plays an important role in the Indian stock market. The impact of Fils can largely be observed at: 1. Stock market 2. Exchange rate 3. Forex reserves Since our analysis is restricted to stock market, therefore, we would analyze the impact of such on Indian stock market. For this purpose an analysis is done to show the relationship between equity returns and FII activities in Indian stock market from the year 2000 to The analysis is based on the popular Bombay Stock Exchange Index (Sensex) comprising of 30 stocks. A correlation test has been done between FII activities and BSE Sensex for the period under consideration. The results are reflected in the table below: Fig. 5.6: Correlation Matrix between FII and BSE Sensex Correlations Net Investment by FII Month-end Index Net Investment by FII Pearson Correlation 1.397" Sig. (2-tailed).002 N Month-end Index Pearson Correlation.397" 1 Sig. (2-talled).002 N **. Correlation Is significant at the 0.01 level (2-tailed). 142

21 The above test shows that there exists a significant positive correlation between FII net investment in Indian stock market and month end index in 10 yearn from Though from above it is evident that FII activities are playing an important role in Indian stock market but it is also true that such degree of dependence of Indian stock market on foreign inflows is not desirable. It is observed from past records that whenever these Fils senses slightest of trouble in the market they withdraws immediately from the market in herds. This attitude of Fils can prove extremely harmful for any emerging economy. Owing to their magnitude of flows, the direction of FII investment flows tends to make or break the fortunes of a market (Kumar et al., 2006). BSE Sensex dipped down by 60%, in the year This is primarily due to the withdrawal of about USD 12 billion from the market by foreign portfolio investors between September and December 2008 and its psychological impact on national investors (Goudarzi et. al., 2011). Despite of all the importance of Fils cannot be ignored in Indian stock market. Past records suggests that they held almost one-third of all assets under the custody of custodians in any period of time Domestic Institutional Investors Domestic Institutional Investors or DII refers to the Indian Institutional Investors who invests in Indian financial market for example stock market. It includes insurances, DFIs, MFs, Banks and Pension Funds. Both FII and DII follow a positive feedback trading mechanism choosing stock market returns. But FIIs react faster than Dlls. As Foreign Institutional Investors have access to both international expertise and talent and even considerable local resources so they are in no way less than domestic investors. Grinblatt and Kelohaiju (2000) and Seasholes (2000) even argue that as 143

22 a result of their better access to expertise and talent, foreign institutions should be smarter than local institutions. Table 5.2: Net Buy/Sell in Indian Stock Market by Various Investors during last 8 Years (Rs. in Cr.) Trade Year Clients NRI Proprietary Dll FII , , , , , , , , , , , , , , , , , , , , , , , Total -69, , , , Source: Data is compiled from and The above statement shows the trading data s of different investors over the period of 8 years. It shows that during the period of stock exchange bull run that begun from , Retail / HNI has continuously sold the shares but during the same period DII & F13 has purchased the shares and BSE market moved from around 5500 to 21,000. In every year where FII remains net buyers, market has moved upwards. In the year, when they sold the shares like in 2008 and 2012, huge correction is seen in the Indian market. In the year 2008, BSE Sensex topped at 21,000-mark and thereafter in May 2008, Sensex crashed with in a period of 15 days to around 9,000 index. Over the long run, i.e. period from liberalization till date, FII remains net buyers most of the time and has provided depth and liquidity in the Indian capital market Only force, which can counter the impact of FII, is DII & Mutual Funds, who are now very active and has got huge amount of money. It has always been seen that in most cases, retail investors buys after the market peaked up and sell when they are under loss and hence, most of time, they do not gain. Among Domestic institutional investors, mutual funds which are active Dlls have already been discussed in 144

23 previous section. Among Non-Institutional investors here we would focus on retail individual investors who are prime focus of the study. Table 5.3: Number of Demat Accounts of Investors (in lakhs) Year as on 31st March NSDL (In lakhs) CDSL (in lakhs) Total Demat (In lakhs) Source: NSDL, CDSL (compiled from various issues ofnsdl Update and CDSL Update) Note: Since number of FII or High Net worth individuals or other DFIs are very few in number so majority of above figures represents Demat accounts of retail investors. From the above table 5.3 it is evident that the number of D-mat accounts has definitely increased over the years. But, again these numbers are still very marginal against the huge population of India. Therefore, to bring depth in Indian stock market and offset the effect of Fils, the participation from retail investors should definitely be increased. Again, out of these Demat accounts of retail investors how many actually operate or trade in the market remains an area of concern Impact of Significant Reforms on Stock Market Development as Measured by Stock Market Development Indicators Previous studies have shown that financial liberalization has always helped in deepening and widening of equity markets where they already existed before reforms. It was observed that the 145

24 expansion of equity markets in many Asian Countries was truly impressive after liberalization process (Clemente, 1994). As Mohan (2005) noted that financial sector reforms in India have been successful in terms of significant improvements in various market segments by effecting regulatory and legal changes, building up institutional infrastructure, constant fine tuning in the market micro-structure and substantial up gradation of technological infrastructure. The financial liberalization provided necessary impetus for the development of Indian stock market. Various significant developments post-liberalization helped the Indian stock market to grow in size and volume. Apart from our above discussion on significant developments in Indian Stock market that have helped the market to reach to new greater heights, such growth could also be measured by using some select stock market development indicators like market capitalization ratio, turnover ratio, value traded ratio, Price- earnings ratio etc. The most commonly used indicator of stock market development is the size of the market measured by stock market capitalization to GDP ratio. The Market Capitalization ratio (MR) is calculated as the value of listed domestic shares on domestic exchanges divided by gross domestic products (GDP). This ratio has improved significantly in India in recent years as shown in the Table 5.4. With gradual reforms initiated in the early 1980s, market capitalization has been steadily increasing along with the number of companies listed on the stock market. Although Indian stock market grew at an impressive rate during the 1980s and 1990s, a comparison with other emerging markets dwarfs its achievements. In Taiwan, the market capitalization ratio rose from 11% in 1981 to 74% in 1991; in Chile between 1983 and 1993, the same ratio rose from 13.2% to 78% and in Thailand from 3.8% to 55.8%. (Glen et al, 2003). 146

25 Table 5.4: Market Capitalization as a Percentage of GDP in India Year Market Capitalization (Rs in Crore) (BSE) Market Capitalization Ratio * *the figures for are till Dee, Source: SEBI, Handbook of Indian Securities Market, 2011 (Table: 22) From the above table it is evident that market capitalization both in absolute terms as well as percentage of GDP has grown over the years. The increase in ratio over the years may be attributable to rise in new listings, rise in stock prices, and number of IPOs. While during to , 3,434 initial public offers (IPOs) amounting to Rs.37, 626 crore were floated, 147

26 during to ,250 IPOs amounting to Rs.43,290 crore were floated. In ,85 IPOs amounting to Rs. 42, 595 crore entered the market. Market capitalization ratio has continued to grow over the years but there was a significant slowdown in market capitalization ratio between and This may be attributable to global slowdown in 2000, other scams and frauds affecting the confidence of investors in Indian stock market etc. Again, market cap ratio showed sharp increase during , and This was mainly due to large participation of foreign institutional investors (Fils) in Indian stock market. This rise in market cap ratio could not sustain in and fell to almost half. The reason for this could be the U.S. Subprime crisis that hit the global market in the year 2008 and had its impact on all developing economies. But, it is worth mentioning here that Indian stock market recovered quickly from global financial crisis and the market capitalization ratio reached 94.1 in As also noted by Mullins (1993), where as the U.S. stock market took 85 years( ) to achieve a similar increase in capitalization ratio, from 7% to 71% (Mullins, 1993). Next to measure stock market liquidity, turnover ratio can be used. The turnover ratio (TR) equals to the value of trades of domestic shares on domestic exchanges divided by value of listed domestic shares. Apart from turnover ratio, value traded ratio is also measure of market liquidity. The value traded ratio (VR) is calculated by dividing the value of the trades of domestic shares on domestic exchanges by GDP. As Levine and Zervos (1998) suggested that the value traded ratio (VR) may also be considered to measure trading volume as a share of national output, and should therefore positively reflect liquidity on an economy-wide basis. The TR measures the volume of domestic equities traded on domestic exchanges relative to the size of the market The turnover ratio on average has shown spectacular rise during postliberalization period. With the liberalization process in Indian stock market, the traded value ratio also showed an upward trend with some slowing down between and The trading volumes in equity segments of the stock exchanges have witnessed tremendous growth during post-liberalization period. The compounded annual growth rate of trading volumes on all 148

27 stock exchanges taken together has been 22.36% over the period to (ISMR, 2011). Table 5.5: Turnover Ratio and Traded Value Ratio. Year Annual Turnover (BSE) (Rs. in Cr.) TR(BSE) (Percent) Traded Value Ratio (BSE) (Percent) , , , , , ,24, ,07, ,10, ,86, ,00, ,07, ,14, ,03, ,18, ,16, ,56, ,78, ,00, ,78, ,05, ,82, Source: Handbook of Indian Securities Market, 2011, SEBI, (Table: 23) and BSE 149

28 With the economic reforms in place, the Indian stock market is now comparable with many major developed and developing economies. As per Standard & Poor s Fact Book 2011, India ranked 7th in terms of market capitalization, 10th in terms of total value traded in stock exchanges and 22nd in terms of turnover ratio, as of December, Another measure of market liquidity is stock market return and volatility. Table 5.6: Stock Index Daily Return Average and Volatility (%) of BSE Sensex from YEAR MEAN S.D * Volatility is the standard deviation of daily logarithmic returns. Source: Handbook of Statistics on Indian Securities Market, 2011, SEBI (Table 22, p. 45) Volatility refers to the spread of all likely outcomes of an uncertain variable. It is related to, but not the same as risk. Risk is associated with undesirable outcome, whereas volatility as a measure of strictly for uncertainty could be due to a positive outcome (Poon, 2005). It is an 150