Indian Financial Reforms Influencing the Bombay Stock Exchange - Essay Example

What impact has financial reforms in India had upon the Bombay stock exchange The design and the operation of Stock Exchanges around the world are usually based on the policies set by the relevant governments in accordance primarily with the financial strength of the countries involved. The appropriate economic theories are being followed at a next level in order to adapt the financial resources available to the current market. In this context, Williamson (1999, 4) has noticed that ‘both mainstream economic theory and the lessons of history appear to suggest that the system that makes the best use of an economys human and natural resources in terms of generating economic output is a competitive, open, market economy’. Specifically for India, economy had to face several obstacles before starting to be developed in all its sectors. Indicatively, Boer et al. (1993, 30) stated that ‘until recently, the Indian economy was one of the most inward-looking and inefficient in the world; mired for years in an elaborate "license raj," companies had to seek permission from bureaucrats to open, close, and even expand their units; exports were paltry, amounting to a few barter deals with the countries of the former Soviet bloc; Tariffs ran as high as 150 percent, effectively keeping imports out’. From the same point of view Patil (2006, 1001) notices that ‘during the early part of the 1990s, the ranking of the Indian capital market with reference to the standard global indices relating to efficiency, safety, market integrity, etc, was not at all flattering; with reference to the risk indices, in particular, the Indian capital market was regarded as one of the worst as it figured almost at the bottom of the league; the same was the case in regard to its efficiency levels in trading and settlement systems’. The above situation has stopped many western companies to proceed to any investment plan in the Indian marketplace. However, in 1991 the country launched a policy of radical liberalization. After that its economy started to be transformed and developed on a continuous basis. According to Boer et al. (1993, 30) ‘this transformation, achieved through a mixture of such macroeconomic measures as curtailing wasteful government spending, slashing tariffs and excise duties, floating the rupee on foreign exchanges, and overhauling the financial system, has already yielded the desired results; the annual inflation rate has been reined back to 7 percent from a high of 17 percent in 1991; the budget deficit is expected to fall, despite the revenue shortfall from lower tariffs, to 4.5 percent of GDP’. Regarding the financial development of the country since 1991, Patil (2006, 1001) states that ‘from the viewpoint of both adoption of sophisticated information technology tools in trading and settlement mechanisms as also the efficiency of capital markets, not only is India ranked in the top league but it is also considered to be way ahead of many developed country capital markets’. It seems therefore that although Indian economy has faced significant obstacles towards its development, the policies and the financial plans applied after 1991 have helped the local economy to achieve a significant growth on a long term basis. In order to estimate the development of Bombay Stock Exchange which is the subject under examination in current paper, we should primarily refer to the general characteristics of India economy. In a report published by World Economic Outlook (2004, 74) it is stated that ‘monetary policy in India has traditionally focused on the twin objectives of maintaining price stability and supporting growth; in the first half of the 1990s, a surge in capital inflows pushed inflation higher but in the second half of the decade, the Reserve Bank of India succeeded in keeping inflation low’. In the above report it is also mentioned that the adoption by the Indian economy of a more flexible exchange regime has helped significantly the financial development of the country. This is a phenomenon applied in all emerging economies in which ‘moving towards more flexible regimes can help to mitigate the risk from currency crises that have characterized pegged exchange rate regimes’ (World Economic Outlook, 2004, 72). In the above context, it is noticed by Kaushik (1996, 62) that ‘Indias progress is not merely an example of how economic reforms have again worked to open up an economy to the benefits of free markets; it is also an example of how the commitment to democracy benefited economic progress as well; in a time when so many believe that democracy should be postponed until economic reforms are completed, Indias success suggests that adhering to democratic values may indeed promote more durable economic growth’. In other words, the above researcher believes that there is a direct relationship between democracy and financial growth, an assumption that can be considered as justified if taking into account the financial development of the countries around the world where democracy is the main characteristic of their political structure. As for the Bombay Stock Exchange market (BSE), it is noticed that it is ‘the country’s largest and oldest stock exchange and was started in 1875, making it Asia’s oldest stock exchange; what started off as a voluntary non-profit making association has evolved into the country’s premier stock exchange; its market share is by far the highest among all the stock exchanges in the country, followed by the Calcutta and Delhi stock exchanges; In 1981, the BSE’s daily turnover was Rs. 4 million a day with 517 brokers. In 1991, the daily turnover went up to Rs. 23 million a day; and the number of brokers increased to only 550’ (Singhal, 2004, 2). The structure and the operation of Bombay Stock Exchange has been also examined by Bullis (1997, 25) who stated that ‘India has twenty-two stock exchanges; the two largest are the venerable 111-year-old Bombay Stock Exchange (BSE) and the fledgling National Stock Exchange (NSE); the two exchanges each cover over 90 percent of Indias market capitalization because the shares of the countrys biggest firms are quoted on both; the BSE provides quotes for a total of 6,000 companies (3,500 of which are actively traded), whereas the NSE just provides quotes for 1,500 of the largest ones’. The performance of BSE as compared with that of NSE shows that although facing a series of operational difficulties, BSE still remains for India its leading Stock Exchange Market although there are also other Stock Exchanges markets (with the NSE to be the most important) that face a significant financial growth. Specifically regarding the operation of BSE Bullis (1997, 25) noticed that this Stock Exchange ‘has a reputation for opacity and not strictly enforcing its rules; a 1995 government report referred to “malpractices and abuses with speculative excesses, price rigging, market manipulation, nonreporting of transactions, evasion of margins, and neglect of the interests of small investors;” it was this reputation, reinforced by a scandal in 1992, that led the Indian authorities to encourage the creation of the NSE as an alternative, in the hope that this would force the BSE to clean up its act’. Regarding the above it is highlighted by Chattopadyay et al. (2006, 1) that ‘besides, the Bombay Stock Exchange is reported to have the highest density of transactions in the world behind only Taiwan; the daily turnover of shares in BSE increased substantially from Rs. 13 crore in 1980-81 to Rs. 2054 crore in 2004-05; due to the policy changes applied in 1991, the market capitalization increased from Rs.3,68,071 crore in 1993-94 to Rs.16,98,428 crore in 2004-05 (Figure 1); the total turnover that reflects the volume of business has also increased gradually over the years (Figure 2)’. Therefore, it seems that any pitfalls of the trading systems used in BSE had not a permanent negative effect on BSE’s growth as the above Stock Exchange still remains the leading one of India. Figure 1, 2 - Performance of Bombai Stock Exchange (Chattopadyay et al., 2006, 1) One of the most significant factors towards the development of BSE has been the foreign investment. Foreign trade also has helped the increase of the country’s financial strength in general and as a result the BSE also achieved high levels of growth. In this context, Dutt et al. (2000, 3) found that India’s foreign trade ‘as a fraction of GDP has grown from around 15% in the 1980s to over 27% in 1995 and 1996; whereas India’s share of world exports fell consistently from about 2% in the 1950sto about 0.6% in the 1970s, and then stayed at around 0.5% from 1973 onwards through the 1980s, the share has now risen smartly to 0.8% in the post-reform period’. Regarding the above issue, in a report published in World Economic Outlook (2004, 74) it is mentioned that before the economic reform in India in 1991 ‘foreign exchange dealers were allowed to use derivatives to hedge their positions (1996-97) and the prudential requirements regarding the risks of foreign exchange exposures were tightened; external financial liberalization was also gradual, and focused on long-term foreign direct investment and equity portfolio inflows; extensive controls on short-term borrowing were retained throughout the 1990s, which together with the existing prudential norms limited foreign exchange vulnerabilities in the banking and corporate sectors and increased Indias resilience during international financial crises’ (World Economic Outlook, 2004, 74). However, after 1991, the introduction of innovated financial policies led to the development of Indian economy. More specifically, it has been found that after 1991 ‘total net foreign investment increased from $154 million to an estimated $4.9 billion in 1994/95 and $4.1 billion in 1995/96; direct foreign investment, thought to be the most stable type of foreign investment, has increased in net terms of $154 million in 1991/92 to close to $2 billion in 1995/96; with the opening up of Indian stock markets to foreigners in 1992 and with Indian companies being given permission to raise funds internationally, portfolio investment has increased to $2.1 billion in 1995/96 from about $1.5 billion in each of the preceding years’ (Dutt, 1997, 68). The above financial development achieved by India after 1991 has been studied by Delong (2001, 2) who noticed that ‘in the 1990s India has been one of the fastest growing economies in the world; at the growth pace of the 1990s, Indian average productivity levels double every sixteen years; if the current pace of growth can be maintained, sixty-six years will bring India to the real GDP per capita level of the United States today; the contrast between the pace of growth in the 1990s and the pace of growth before 1980--with a doubling time of fifty years, and an expected approach to Americas current GDP per capita level not in 2066 but in 2250--is extraordinary’. In the above context, it is noticed by Chandrasekhar (2003) that Indian Stock markets, therefore BSE also, have the advantage of low taxation which can be an issue that can lead to the significant increase of current foreign capital invested in India. More specifically, the above researcher states that ‘government guidelines, upheld now by the Supreme Court, ensure that firms based in Mauritius with uncertain residential prerequisites would be eligible for the benefits offered by the double-taxation treaty between India and Mauritius; this implies that taxation of stock market gains would be lower and the rates of return offered by Indian markets higher if investments occur through the `Mauritius route’ (Chandrasekhar, 2003, 20). However, there may be sectors that are still difficult to be approached by the foreign investors. In a report published by the Trade Compliance Center (1997) of India, it is noticed that ‘all sectors of the Indian economy are now open to foreign investors, except those which raise security concerns such as defense, railways and atomic energy; as a result, the $12 billion in foreign investment approved between January 1991 and August 1995 exceeded the nominal dollar value of all foreign investment approved during the previous four decades, with U.S. investors taking the lead’. However, despite the above restrictions, the financial growth of India has not been limited. On the other hand, it is mentioned by Dutt et al. (2000, 5) that in India ‘the expected growth effects of portfolio inflows have not been fulfilled; it is clear that the volatility of stock prices has increased, partly due to the growing influence of the Foreign Institutional Investors (FIIs), a direct consequence of deregulation; this rising influence also makes the markets increasingly sensitive to political uncertainty which has also risen during the 1990s; while the volume of household savings held in the form of shares and debentures and in units of the Unit Trust of India (a public sector mutual fund) has risen 35-fold since 1980-81, the overwhelming part of this reflects a shift from bank deposits to stocks; after the sharp falls in stock prices mentioned above, the share of stocks has gone down again in favor of bank deposits’. However, the above remarks involved the performance of a specific financial period, this of 1999/ 2000 which was a year with severe financial turbulences for all the countries around the world. So, the results of the Indian economy as presented above specifically for that period should not be considered as indicative of the country’s financial performance in general. However, there is also the opinion of Chandrasekhar (2003) who seems to agree with the views of the previous researcher. More specifically, Chandrasekhar (2003, 21) states that ‘it is widely accepted that despite the moderate recovery in industrial growth in 2002-03, the Indian economy has for the last few years been experiencing slow growth relative to the record of the mid-1990s; liberalisation, that seemed to be triggering a post-crisis boom after 1992, has failed to sustain that growth since about 1998; one set of reasons for this is the contraction induced by the reduction in the tax-GDP ratio associated with liberalisation and the drag on the fiscal deficit associated with fiscal reform’. In this context, Luna (2006, 38) believes that privatization could help India to face successfully all problems related with the slow performance of its economy (and its Stock Exchanges). More specifically, the above researcher notices that ‘in 2003, the government was able to sell off a 27.5 percent stake in Indias largest car manufacturer, Maruti; the sale of Maruti, which helped to revitalize the Mumbai stock market, was one of Indias most successful, resulting in bids from over 300,000 investors; such favorable privatization has the possibility, if it is not restrained by governmental opposition, to enhance Indias competitive business environment in the long term while also improving economic efficiency’. In other words, Luna believes that privatization could help the India economy to achieve higher levels of growth while he uses the case of the growth achieved by BSE after a relevant effort as an indicative example of this prospect. At a next level, exchange rates are mentioned as having significant importance for the growth of an Exchange market. More specifically, Prakash et al. (2000, 1095) mentions that ‘many market participants, namely, international investors, banks, nonbank financial institutions, portfolio managers, are interested in coming up with a model which accurately predicts exchange rates while managers of multinational corporations are interested in accuracy of such foreign exchange prediction models as it directly impacts their activities relating to exposure management, hedging, arbitraging, investment and financing decisions’. The response of the policymakers towards the above demands is not always the expected one. Primarily, it is noticed by Prakash et al. (2000, 1095) that ‘policymakers frequently monitor exchange rates to better understand their impact on trade positions, and consequently, domestic employment, business and revenue prospects however difficulty in exchange rate forecasting of emerging countries can lead to a constant rebalancing of portfolios held by international institutional investors; given that the total investible portfolio of institutional investors is very large and any marginal increase in their investments in emerging markets will be translated into a significantly large capital inflow relative to market capitalizations in these markets’. In other words, even if the efforts made by the policymakers can be considered as adequate taking into account the conditions applied in a specific Stock Exchange Market, the demands of investors can involve in several other elements that could not be specified in advance by any authorized body. Therefore, the existence of a governmental authority that should deal specifically with these issues could be really helpful towards the increase of the foreign capital invested in a particular country. 2002(a) 2003(a) 2004(a) 2005(a) 2006(b) GDP at market prices (Rs bn)(c) 24,497.4 27,602.2 31,214.1 35,314.5 39,771.8 GDP (US$ bn) 506.1 595.0 691.6 797.5 875.9 Real GDP growth (%)(d) 3.6 8.3 8.5 8.5 8.7 Consumer price inflation (av; %) 4.3 3.8 3.8 4.2 6.1 Population (m) 1,034.2 1,049.7 1,065.1 1,080.3 1,095.4 Exports of goods fob (US$ m) 51,153.0 60,895.0 77,939.0 102,213.0 119,396.6 Imports of goods fob (US$ m) -60,723.0 -75,537.0 -105,975.0 -149,414.0 -186,307.1 Current-account balance (US$ m) 7,061.0 8,773.0 781.0 -8,321.0 -15,006.2 Foreign-exchange reserves excl gold (US$ m) 67,666.0 98,938.0 126,593.0 131,924.0 161,794.8 Total external debt (US$ bn) 104.8 112.6 122.7 126.2(b) 135.7 Debt-service ratio, paid (%) 14.8 18.6 13.4 13.4(b) 7.9 Exchange rate (av) Rs:US$ 48.61 46.58 45.32 44.10 45.30 (a) Actual. (b) Economist Intelligence Unit estimates. (c) Fiscal year beginning April 1st of year indicated; seasonally adjusted; includes statistical discrepancy. (d) Fiscal year beginning April 1st of year indicated. Table 1 – Economic Structure of India (Economist, 2007) Generally, it is noticed by Kaushik (1996, 65) that ‘Indias economic and financial reforms are timely and appropriate for creating confidence among domestic as well as foreign investors; foreign capital is important for its technological and economic multiplier effects; India has reached the apex of the pyramid of confidence, which it should maintain while implementing further reforms to broaden and deepen that confidence’. However, the above development should be supported by the appropriate rules and control in order to last for a long period of time. It is for this reason that it has been highlighted by Zacharakis (1997, 23) that ‘international expansion involves risks, including political instability in the target market, expropriation, social unrest, fluctuating exchange rates, poor infrastructures, host government regulations, differing language, norms, religion, and legal systems’. From the same aspect, the financial development of a country cannot be retained in the future unless based on appropriate planning and control. The BSE example shows that the introduction of innovative economic measures can help the development of a country’s economy in all its sectors. However, the control over the application of these measures in practice is necessary in order for any malpractices to be avoided. The existence of turbulences of course should be regarded as a normal phenomenon, however with the appropriate political and economic basis, a country’s economy could not be affected even when facing extremely adverse conditions. References Boer, K., Fell, G. (1993) A Fresh Look at India. The McKinsey Quarterly, 2: 29-37 Bullis, D. (1997) Selling to Indias Consumer Market. Westport: Quorum Books Chandrasekhar, C. P. (2004) Influencing Economic Policy using the Stock Market, available at http://www.countercurrents.org/eco-chandrasekhar260504.htm Chandrasekhar, C.P. (2003) The stock market as casino. The Frontline, 20: 22-23 Chattopadhyay, S., Behera, S. (2006) Financial Integration for Indian Stock Market. Department of Economic Analysis and Policy. Reserve Bank of India, Mumbai, 1-29 Delong, B. (2001) Preliminary Thoughts on India’s Economic Growth, available at http://www.j-bradford-delong.net/TotW/India.html Dutt, A. K., Rao, M. (2000) Globalization and its Social Discontents: The Case of India. Center for Economic Policy Analysis, working paper 16, New School University, NY Dutt, A. K. (1997) The Political Economy of Indian Economic Reform. Journal of International Affairs, 51(1): 57-72 Economist, (2007) Economic Structure of India, available at http://economist.com/countries/India/profile.cfm?folder=Profile-Economic+Structure Jacob, R. (1996) India – Can Economic Reform Survive? Time International, 147: 22 Joshi, V., Little, I.M.D. (1996) Indias Economic Reforms 1991-2001. Oxford: Clarendon Press Kaushik, S. (1996) Indias Democratic Economic Transformation. Challenge, 39(5): 54-67 Little, I.M.D., Scitovsky, T., Scott, M. (1970) Industry and Trade in Some Developing Countries. Oxford: Oxford University Press Luna, J. (2006) Indias Emerging Economic Prowess. Harvard International Review, 27(4): 36-42 Patil, R.A. (2006) Current State of the Indian Capital market. Economic and Political Weekly, 1001-1010 Prakash L. D., Raj, M. (2000) An Investigation in Exchange Rate Behavior of Emerging Countries. International Journal of Public Administration, 1089-1112 Singhal, R. (2004) Financial Sector Reform in India: Is there a grand design? Center for the Advanced Study of India. University of Pennsylvania Trade Compliace Center (1997) India - Country reports on economic policy and trade practice – 1997, available at http://www.mac.doc.gov/tcc/data/commerce_html/countries/Countries2/India/CountryReports/1997/KeyEconomic.html Williamson, J. (1999) Economic Reform: Content, Progress, Prospects. Peterson Institute, University of Baroda World Economic Outlook. (2004) Chapter II: Three Current Policy Issues, 71-89 Zacharakis, A. (1997). Entrepreneurial Entry into Foreign Markets: A Transaction Cost Perspective. Entrepreneurship: Theory and Practice, 21(3): 23-38 Read More