Impact of Financial Reform upon the Bombay Stock Exchange - Essay Example

What impact has financial reforms in India had upon the Bombay stock exchange Since 1980’s the main characteristics of political and economic framework in India had been the extended and radical changes in all sectors related with economy and the commerce in general. In this context, Reed (2001, 175) noticed that ‘a New Economic Policy reflecting this careful balancing between state withdrawal and state support was developed first by Indira Gandhi in the early eighties, and carried further by Rajiv Gandhi who succeeded her as prime minister; tax concessions to higher income groups and to corporations were one of the primary instruments of demand management while substantial increases in salaries in the government and government-related sectors (such as higher education) and an unprecedented expansion of employment in the public sector were other measures; as a result of these measures, industrial growth did revive, led by a phenomenal growth in consumer durables ranging from 8 to 22 per cent per annum during the period’. However, it seems that the above developments were not the only element of the political and economic reform of the period under consideration. On the other hand, there were major issues that had been taken into account by the policy makers of that time. More specifically, it has been found that ‘prior to 1991, capital flows to India predominately consisted of aid flows, commercial borrowings, and nonresident Indian deposits; while direct investment was restricted, foreign portfolio investment was channeled almost exclusively into a small number of public sector bond issues, and foreign equity holdings in Indian companies were not permitted; while deposits to Indian banks by nonresident Indians were allowed, restrictions were placed on the interest paid’ (Cerra et al., 2002, 396). It is proved therefore that before the active involvement of the state and more specifically of the economic policy makers in the country’s economic structure India’s commercial market was rather hostile towards the foreign investors. Towards that direction ‘beginning in July 1991, the country systematically liberalized its economy; prior to 1991, a complex maze of quantitative restrictions, foreign-exchange controls and tariff rates averaging well over 120 percent (and rising as high as 400 percent) characterized trade policy while today, virtually all import quotas except those on consumer goods and a few intermediate inputs and capital goods are gone, the rupee is convertible on the current account, and tariff rates are capped at 65 percent’ (Panagariva, 1994, 193). In order however for the relevant transactions to be safe for the foreign entrepreneurs a regulatory body, the Securities and Exchange Board of India (SEBI), ‘was set up in 1988: it was given statutory powers in January 1992 and these powers were reinforced in 1995; SEBI faced a delicate task; It had to acquire a reputation for strength and independence in the face of opposition from entrenched interests, such as the broking community, but it also had to avoid being hamfisted and hyperactive’ (Joshi et al., 1996, 154). The existence of the above body could guarantee the security of transactions taking place in the country’s stock exchanges as well as in the various financial institutions that offered such an option to their clients. At a next level, it should be highlighted that one of the most significant areas of India economy is country’s Stock Exchange Market. Moreover, until 1994 the premier Exchange market of India was that of Bombay. However, in 1994 the ‘National Stock Exchange market begun its operations and has dramatically transformed the Indian Stock market’ (Krishnamurti et al., 2004, 2). The above two Exchange markets have been since then in a continuous and intensive competition trying to ‘capture’ the largest portion of foreign capital entering the country. However, it seems that the creation of National Exchange market has been a necessity for India in order to develop its financial performance. It should be mentioned here that ‘prior to the creation of National Stock Exchange India ranked last among 12 emerging markets on settlement, safekeeping and operational risk’ (Krishnamurti et al., 2004, 2). The above problems were mainly connected with the fact that especially before the country’s economic reform the rules and the principles applied in the local financial markets were limited and in most cases they were ignored by the relevant participants. However, after the economic reform and especially after the creation of National Stock Exchange, the Indian financial market as a whole – including the Bombay Exchange Market – is facing a continuous and significant development while the foreign capital invested in the country presents a stable growth. It should be noticed here that ‘Indias financial system is composed of three elements: banks, term-lending institutions, and non-banking finance institutions; despite participation from private institutions, sixteen public sector banks control a significant portion of banking activities in India; Public sector banking is divided evenly between nine banks in the state bank group (State Bank of India, State Bank of Saurashtra, State Bank of Hyderabad, State Bank of Bikaner, State Bank of Travancore, State Bank of Indore, State Bank of Mysore and State Bank of Patiala) and nineteen nationalized public commercial banks and development finance institutions. The second category of public sector banks includes Indias largest four public sector banks (Bank of India, the State Bank of India, the Bank of Baroda, and the Dena Bank)’ (Saez et al., 2001, 73). The reference to the country’s economic structure particularly of the banking sector is made in order for the relevant analysis of India’s prospects for growth to be more comprehensive. Moreover, it should be noticed that one of the most significant elements of the country’s economic operation is the price given to the exchange rate. In this context, it has been mentioned by Cerra et al. (2002, 396) that in mid-1991 India’s exchange rate ‘was subjected to a severe adjustment; this event began with a slide in the value of the rupee leading up to mid-1991; the authorities at the Reserve Bank of India slowed the decline in value by expending international reserves; with reserves nearly depleted, however, the exchange rate was devalued sharply on July 1 and July 3 against major foreign currencies’ (Cerra et al., 2002, 396). In other words, the dependence on the foreign capital is extremely high for India. The country has many times alternated its financial policy in accordance with the level of the foreign funds invested in the Indian economy, a fact that has been proved to influence negatively the stability of the country’s financial markets. Towards this direction, Panagariva (1994, 195) has studied the level of liberarization of the foreign investment in India and has found that ‘once hostile to foreign investment, India now actively seeks it; where once the share of foreign equity in joint ventures was rarely allowed to exceed 40 percent, automatic approval is now given for foreign equity up to 51 percent in 35 selected industries; these industries cover approximately 50 percent of the value-added in manufacturing. Foreign equity above 51 percent is also permitted on a case-by-case basis by the Foreign Investment Promotion Board, housed in the Prime Ministers office’. The role of foreign investment to India’s economic development has also been studied by DeMeza et al. (1987) who found that although the level of foreign capital in India is extremely high, in many cases the information provided is not accurate and as a result the country’s Stock Exchanges suffer significant losses. However, the development of foreign commercial activities cannot be completed without the appropriate regulation of the state – owned enterprises which can create severe obstacles to the development of the country’s economy in general. It has to be noticed that after studying this particular issue Saez et al. (2001, 71) stated that ‘India and China have begun a complex process of deregulation of its large public sector enterprises; The process of deregulation began in the early 1980s in China; Indias deregulation program began a decade later once the central government removed most industrial licensing requirements; These public sector enterprises account for half of their respective economys capital stock and also account for over a quarter on non-agricultural gross domestic product’. The above researchers examine the position of state owned enterprises in India as it can be evaluated with comparison to China. These two countries can be considered to have many common elements to their economic structure as they both refer to developing countries which have managed to enhance their economy mainly by offering the chance to foreign investors to participate to the local financial markets, i.e. by promoting appropriately their economy to the global marketplace. It should be noticed however that although the two countries present many similarities in their economic structure, they have major differences in the area of political conditions. China is based mainly in the ‘collectivism’ where India has a more ‘Western’ style of political structure, a fact that possible gives to its economy the advantage of higher flexibility under the turbulences taken place in the global financial market. Figure 1 - Market Capitalisation of Largest Indian Companies: International Finance Corporation (IFC) versus the Bombay Stock Exchange (BSE) (as in Reed, 2001, 179) Under the above terms, the country has put as a priority the protection of foreign investors from possible fraud as it can take place during the daily financial transactions but mostly in the area of Stock Exchange market (Binswanger et al., 1992). For this reason, a series of relevant legal rules has been introduced – mainly after the country’s economic reform. It should be mentioned that ‘prior to reform, under the Capital Issues (Control) Act, firms were required to obtain approval from the Controller of Capital Issues for raising capital and fixing the premium on the issue price; this Act was repealed in 1992 while the statutory control on flotation and pricing of issues has been abolished, subject only to certain disclosure requirements’ (Joshi et al., 1996, 154). The participation of the State in the development of the country’s financial performance has been therefore intensive and direct (Bardhau, 1984), especially after the reform of India’s economic structure. The country has been proved as having the potentials for a high level of growth despite the extremely hostile global marketplace which ‘fights’ the development of its members especially when these belongs to the ‘zone’ of ‘developing countries’. Towards this direction, the Bombay Exchange market should be considered as offering a significant help to India’s financial development even under the pressure caused by the instability in the foreign capital entering the country. References Bardhan, P. (1984). The Political Economy of Development in India. Oxford: Basil Blackwell Binswanger H., Khandker, S. (1992). The Impact of Formal Finance on the Rural Economy of India. World Bank Policy Research Working Paper No. 949, Washington DC Cassen R., Joshi, V. (1995). India--The Future of Economic Reform. New Delhi: Oxford University Press Cerra, V., Saxena, S. (2002) What Caused the 1991 Currency Crisis in India?. IMF Staff Papers, 49(3): 395-421 DeMeza D., Webb, D. (1987). Too Much Investment: A Problem of Asymmetric Information. Quarterly Journal of Economics, 102: 281-92 Joshi, V., Little, M. (1996) Indias Economic Reforms, 1991-2001. Oxford: Oxford University Krishnamurti, C., Limi, E. (2004) ‘Competition Liquidity and Volatility – a comparative study of Bombay Stock Exchange and National Stock Exchange’ Division of Banking and Finance, Nanyang Business School, Nanyang Technological University Panagariva, A. (1994) India: A New Tiger on the Block. Journal of International Affairs, 48(1) 193-221 Reed, M. (2001) Perspectives on the Indian Corporate Economy: Exploring the Paradox of Profits. New York: Palgrave Saez, L., Yang, J. (2001) Deregulation of State-Owned Enterprises in India and China. Comparative Economic Studies, 43(3): 69-78 Read More