59

CHAPTER IV

HISTORICAL OVERVIEW OF STOCK MARKET IN INDIA

4.1. Evolution and Growth of Stock Market in India

Stock market in India has a long and chequered history. Bombay Stock

Exchange, the first stock exchange of the country was established as early as in 1875,

predating the Tokyo Stock Exchange by three years. Over these years Indian stock

market has passed through diverse fortunes. The historical evolution of Indian stock

market through four distinct phases is described in this section.

4.1.1. Early Beginnings

The stock market in India dates back to the 18th century when the securities of

the East India Company were traded in Mumbai and Kolkata. Stock broking was not

very popular in those days and in Mumbai, during 1840 and 1860, there were only half

a dozen brokers recognised by the banks and merchants. The securities traded were

mainly shares, debentures and bonds representing titles to property or promises to pay

issued on the condition of transfer from one person to another.

The real beginning of trading in corporate securities came in 1850 when the

Companies Act, introducing joint stock companies with limited liability, was passed.

The following period witnessed rapid development of commercial enterprises, which

made investments in stocks and shares popular. In Mumbai and Kolkata, shares of

banks, cotton mills and loan securities of East India Company were being transacted

60

in large volume. The cotton boom of the 1860’s has added further impetus to trading

in securities. The American Civil War (1860-61), which caused to cease the supply of

cotton from the United States to Europe, was a boon for cotton industry in India. There

was an unlimited demand for cotton from India and cotton exporters gained

substantially. The export proceeds in gold and silver served as fresh capital for a

number of new ventures. Many new companies were started in a variety of fields such

as banking, land reclamation, trading, cotton cleaning, pressing, shipping and

construction. Banks were following a reckless lending policy during this period. The

excessive speculation coupled with the reckless lending policy resulted in a stock

market boom. Any scrip that was floated in the 1860s commanded a very high

premium. The steep rise in share prices attracted many people to the stock exchange.

However, this boom was short-lived. As the Civil War ended, a disastrous

slump followed in India, and the Indian capital market witnessed the first shock in

1865. Though the depression was severe and long, the share mania of the 1860s

created some positive effects. It led to the establishment of a regular and liquid market

for securities, developed an equity cult among the investors, and helped to make

Mumbai the chief centre of the money and capital market and the financial capital of

India.

The boom and the burst had its impact on the share brokers too. The number

of brokers increased significantly during the period of share mania and it stood at 250

in 1865. The slump brought many failures to the brokers also. This brought brokers in

Mumbai together to form the first formally organised stock exchange in the country-

The Bombay Stock Exchange. It was formed as a society named Native Share and

61

Stock Brokers Association, in 1875. Subsequently, stock exchanges were set up at

Ahemedabad, Kolkata and Madras in 1894, 1905 and 1908 respectively.

4.1.2. Period of Repression (1947-1980)

At the time of Independence though India inherited a poor economy, it had one

of the best formal financial markets in the developing world. There were four

functioning stock exchanges with clearly defined rules governing listing, trading and

settlement, 1119 listed companies with the market value of capital Rs.971 crores, a

developed equity culture, if only among the urban rich; and a banking system with

well developed lending norms and recovery procedures. In terms of corporate laws

and financial system, India was better endowed than many of the erstwhile colonies.

The Companies Act, 1956 as well as other laws governing joint stock companies and

investor protection was built on this foundation (Allen, et al, 2007).

However, in this period, the role assigned to the financial system was limited,

with primary role assigned to the state and its agencies for mobilisation and allocation

of savings. Accordingly in the process of capital accumulation, the role of the financial

system was essentially limited. To a large extent, financial system also had a limited

role in providing incentives for savings and capital accumulation as interest rates were

controlled and household savings were pre-empted through high levels of statutory

reserve and liquidity ratio. The industry depended less on mobilisation of resources

through shares and debentures on account of the administered interest rate structure,

and the credit deployment by the banks and financial institutions were at relatively low

rates of interest (Jalan, 2002). As far as external finance was concerned, the country

relied primarily on bilateral and multilateral official development and did not

62

encourage private external capital inflows as a way to supplement domestic savings.

Hence, there was no noticeable development in respect of the structure and working of

capital market of the country, and it remained more or less repressed during this

period.

During the 1950’s and 1960’s, the demand for long- term funds was not

significant, partly due to weak industrial base and partly due to the low saving rate. In

terms of the participation of investors also, this period did not witness substantial

progress. However, this period was characterised by the enactment of a number of

basic legislations covering different aspects of the securities market, i.e., Capital

Issues (Control) Act, 1947; Securities Contracts (Regulation) Act, 1956; Companies

Act, 1956; and the Foreign Exchange Regulation Act (FERA), 1975. The FERA

legislation restricting the shareholding of foreign firms in joint ventures to 40 per cent,

made many well managed multinational companies to offer their equities to the public

at the regulated low prices during the 1970’s. Encouraged by the good response to

such issues, a large number of domestic public limited companies offered new capital

issues for public subscription. Consequently, the stock market exhibited an upward

trend with share prices displaying high level of buoyancy (Misra, 1997). By the end of

1980, the number of exchanges increased to nine with 2265 companies listed on them

and the market value of listed capital aggregated at Rs.6,750 crore. For the first time,

awareness was created among the common investors about the potential of equity

investments as a hedge against inflation and a source of higher earnings compared to

the other forms of investments. The number of share owning population as a

63

proportion of total population registered a nominal rise from 0.12 per cent in 1955 to

0.36 per cent in 1980.

4.1.3. Period of Change (1980-1992)

The period from 1980 to 1992 can be termed as a period of change, signifying the

widening and deepening of the capital market in India (Misra, 1997). Since the mid-

eighties, debentures emerged as a powerful instrument of resource mobilisation in the

primary market. The introduction of public sector bonds since 1985-86 imparted an

additional fillip to the stock market. The mutual fund industry was widened, by

permitting banks to set up mutual funds as subsidiaries. All these resulted in the

growth of stock market in terms of number of exchanges, listed companies, their paid-

up capital and market capitalisation. It also witnessed the emergence of several

specialised institutions such as the Securities and Exchange Board of India (regulatory

body), CRISIL, CARE and ICRA (credit rating agencies), SCHIL (custodial service),

OTCEI (screen-based stock exchange), mutual funds and venture capital companies.

By the end of this phase ten new exchanges were set up in the country, taking the total

number of exchanges to 19. The number of listed companies multiplied to 5968 with

their listed value rising to Rs.27, 761 crore and market value to Rs. 55,406 crore. The

proportion of share owning population increased to 1.2 per cent of the total population

by the end of 1991. A number of Committees, relating to the development and

working of the capital market, were set up during this phase. These included the

Committee on the Organization and Management of Stock Exchange,1986 (Chairman:

G.S.Patel), the Working Group on the Development of the Capital Market,

1989(Chairman: Abid Hussain), the High Powered Study Group on Establishment of

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New Stock Exchanges,1991(Chairman: M.J.Pherwani) and the Committee on Trading

in Public Sector Bonds and Units of Mutual Funds,1992(Chairman: S.S.Nadkarni). A

number of reform measures were implemented on the recommendations of these

committees to streamline the operations of the stock market.

However, large-scale irregularities existed in the basic structure and operational

procedures of the stock market. The Bombay Stock Exchange (BSE) monopolised the

Indian stock market. The BSE, which was an association of brokers, imposed entry

barriers leading to elevated costs of intermediation. Trading at that time was mainly

through ‘open outcry’ on the trading floor and there was no price-time priority, so

users of the market were not assured that a trade was executed at the best possible

price. Moreover, there existed inefficiencies in clearing and settlement procedures.

The market mainly followed fortnightly settlement cycle, in which, trading was

supposed to take place for a fortnight until a predetermined expiration date. Open

positions on the expiration date only would go to actual settlement, where funds and

securities were exchanged. Besides, a market practice called badla allowed the

brokers to carry positions across settlement periods. In effect, even the open positions

at the end of the fortnight did not always have to be settled. All these problems led to

an extremely poor functioning of equity market in the early 1990’s. From the late 1992

onwards, the Indian state embarked on a radical reform programme, which completely

transformed the stock market (Shah and Thomas, 1997).

4.1.4. Period of Structural Transformation (1992- )

The period from 1992 onwards witnessed several policy initiatives which

refined the structure and operations of the stock market. The process of economic

65

reforms and liberalisations set in motion in the mid-eighties was accelerated in the

wake of severe foreign exchange crisis, declining industrial production, galloping

inflation and rising fiscal deficit. The state-dominated development paradigm followed

by the country has shifted sharply towards a more market determined-strategy of

development since 1992. The change in the development paradigm also led to a

change in the perception about the role of the financial system in development, Banks,

financial institutions and capital market has recognised as important instruments for

allocating savings among alternative investment choices according to their relative

efficiency. Accordingly, the securities market reforms were launched in 1992, based

on the recommendations of the Pherwani, Dave, Nadkarni and Narasimham

Committees and the Standing High Level Committee on Capital Markets, which

included measures for its liberalisation, regulation and development.

Specifically these reforms included: repeal of the Capital Issues (Control) Act,

1947, through which the Government used to expropriate seignoirage and allocate

resources from capital market for favoured uses; the enactment of the Securities and

Exchange Board of India Act, 1992 to assign statutory status to the SEBI; free pricing

of securities according to market sentiments; permitting private financial institutions

to set up mutual funds and foreign institutional investors to participate in the stock

market; setting up of the National Stock Exchange in 1993; passing of the

Depositories Act, 1996 to provide for the maintenance and transfer of ownership of

securities in book entry form; amendments to the Securities Contracts(Regulation)

Act, 1956 in 1999 to provide for the introduction of futures and options, and the

introduction of rolling settlements in securities trading etc.

66

Since 1992 India has experienced two stock market booms one in 1992-93 and

the other in 1999-2000.The first boom reflected the price deregulation and was driven

by the liberalisation wave. During this period many firms found it cheaper to raise

funds from the capital market causing a rapid increase in the number of listed firms

from 6925 in 1992 to 9077 in 1995. Also, the share of market capitalisation in GDP

rose from 32 per cent in 1992 to 46 per cent in 1995. Equity finance however declined

thereafter till 1999. The main causes for this decline are: investors’ realisation that

stock prices are over valued in the primary market, a decline in the public confidence

in the equity market due to a series of scams and malpractices during 1992-93, and

reduced inflow of foreign capital due to Mexican and South Asian crisis. The stock

market experienced another boom in 1999 in the wake of the IT boom, relaxation of

IPO requirements for IT firms, and the reduction in the capital gains tax from 20 per

cent to ten per cent. The per cent of market capitalisation in GDP has increased from

34 per cent in 1999 to 85 per cent in 2000. However, the number of listed companies

registered only a mild increase to 9800 (Shirai, 2002).

In the mean period there were three scams as well. The first one experienced

in 1992 was triggered by financial manipulations by Harshad Mehta, the second in

2000 by the UTI fiasco and third in 2002 by another broker giant Ketan Parekh.

Second generation reform measures included the introduction of Rolling

Settlement in 2001, banning of all deferral products such as carry forward,

commencement of trading in futures and options, setting up of clearing corporation for

government securities and dematerialisation of debt instruments. These reforms were

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aimed at creating efficient and competitive securities market by overcoming various

shortcomings of the market.

Table 4.1

Select Market Participants in the Stock Market

Market Participants Number (March 31,2005)

Securities Appellate Tribunal 1

Regulators 4

Depositories 2

Stock Exchanges

With Equities Trading

With Debt Segments

With Derivatives Trading

23

23

1

2

Brokers 9128

FIIs 695

Source: NSE-ISMR, 2005, pp. 2

The process of reforms has led to a pace of growth almost unparalleled in the

history of any country. Stock market in India has grown exponentially as measured in

terms of amount raised from the market, number of stock exchanges and other

intermediaries, the number of listed stocks, market capitalisation, trading volumes and

turnover on the stock exchanges, number of transactions, investor population and price

indices. Along with this, the profiles of the investors, issuers and intermediaries have

changed significantly. The market also witnessed fundamental institutional changes

resulting in drastic reduction in transaction costs and significant improvements in

efficiency, transparency and safety. Besides, the wave of global integration initiated

by the entry of FIIs and strengthened by the introduction of depository receipts has

68

made India a centre of attraction for global investors. All these have made Indian stock

market comparable to developed stock markets of the world in various aspects.

India has a turnover ratio of 113.7 per cent which is quite comparable with the

developed markets such as U.S.A. and U.K. which has turnover ratios of 126.5 and

140.5 respectively. The S&P Fact Book (2005) ranked India 18th in terms of market

capitalization and 18th in terms of total value traded in stock exchanges and 16th in

terms of turnover ratio as of December, 2004. India ranked second in terms of listed

securities and is next only to the U.S.A.

Table-4.2

Stock Markets- An International Comparison (As on December, 2004)

Particulars U.S.A. U.K. Japan Germ

any Singapore

Hong Kong

China India

No.of Listed Cos. Market capitalisation ($ Bn) Market capitalisation ratio (%) Turnover ($ Bn) Turnover ratio (%)

5,321

16,324

148.2

19,555

126.5

2,486

2,816

167.6

3,707

140.5

3,220

3,678

84.7

3,430

103.5

660

1,195

57.3

1,486

123.7

489

172

190.1

81

51.2

1,086

861

488.8

439

55.7

1,384

640

45.2

748

113.3

4,730

388

68.0

379

113.7 Source: NSE ISMR 2000, pp.3

A comparative study of concentration of market indices shows that the index

stock’s share of total market capitalisation in India is 73.3 per cent where as it as US

index accounted for 92.6 per cent. The ten largest index stocks share on total market

capitalisation is 33.4 in India and it is 14.7 in case of U.S. (Table 4.3).

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Table - 4.3

Market Concentration in Major Stock Markets (as on end 2004)

Country Index Stocks Share of

Total Market Capitalisation

Largest 10 Stocks share

of Total Mkt. Capitalisation

Japan 97.1 18.2

Singapore 94.6 34.2

France 75.1 35.6

Germany 87.1 45.1

Italy 98.8 57.2

U.K. 95.9 40.9

U.S.A. 92.6 14.7

India 73.7 33.4 Source: NSE-ISMR, 2005, pp. 4

4.2. Reforms in Indian Stock Market

Since the initiation of the financial liberalisation programme in 1992, there

have been substantial regulatory, structural, institutional and operational changes in

the securities market of the country. These reforms were carried out with the objective

of improving market efficiency, enhancing transparency, preventing unfair trade

practices and bringing the Indian securities market up to international standards. Major

reform measures undertaken were the following.

4.2.1. SEBI as a Statutory Body

The Securities and Exchange Board of India (SEBI) set up as an

administrative body in April 1988, was given statutory status on November 1992 by

the promulgation of the SEBI Ordinance. The objective of setting up of SEBI is to

protect the interest of investors in securities, and to promote the development of

70

securities market and to regulate it. Its regulatory jurisdiction extends over corporate

bodies in the issuance of capital and transfer of securities and to all the intermediaries

and persons associated with securities market. After the repeal of the Capital Issues

(Control) Act 1947 in 1992, SEBI has vested with the powers so far exercised by

Controller of Capital Issues. SEBI has the responsibility of prohibiting fraudulent and

unfair trade practices relating to securities market and of regulating substantial

acquisition of shares and takeover of companies. SEBI also has the powers to impose

monetary penalties and to levy fees from market intermediaries. In a recent

amendment to the SEBI Act, the regulator has also been given search and seizure

powers.

4.2.2. Introduction of Screen-Based Trading

Prior to 1990’s, the trading on stock exchanges in India used to take place

through floor-based open outcry system, which was inaccessible to users. This system

neither allowed immediate matching or recording of trades, nor did it provide price-

time priority, which made it difficult to ensure that a trade was executed at the best

possible price. Besides, this system was time consuming and resulted in high

transaction costs. In order to provide efficiency, liquidity and transparency in

securities trading, fully automated screen based trading system was introduced in most

of the stock exchanges. The NSE pioneered this system of trading by launching the

automated trading system NEAT in1993. Following NSE, BSE introduced BOLT in

1995 and many other exchanges followed suit. In on-line trading system orders are

electronically matched on price-time priority and hence cut down on time and cost. It

enables market participants to see the full market on real-time, making the market

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transparent. It also allows a large number of participants, irrespective of their

geographical locations, to trade with one another simultaneously, improving the depth

and liquidity of the stock market.

4.2.3. Entry of Foreign Institutional Investors

As part of a move towards global integration, foreign institutional investors

(FIIs), were allowed to invest in the Indian securities market from September, 1992.

However, investments by them were first made in January 1993. Each FII need to be

registered with SEBI initially for a period of five years and it can operate through

opening an office in India or through a sub-account with a local company. All FIIs are

required to buy or sell only for delivery and they are not allowed to offset a deal or to

sell short. FIIs are permitted to trade in exchange traded derivatives from June 1998.

As per the original policy of 1992, registered FIIs could individually invest in a

maximum of five per cent of a company’s issued capital and all FIIs together up to a

maximum of 24 per cent. The five per cent individual FII limit was raised to ten per

cent in June 1998. As of March 2001, FIIs as a group were allowed to invest in excess

of 24 per cent and up to 40 per cent of the paid up capital of a company with the

approval of the general body of the shareholders granted through a special resolution.

It was further enhanced to sectoral FDI limit in September 2000. Now, investments by

the FIIs have become a crucial factor in the movement of share prices in India. They

also have an impact on stock market behaviour mainly through effects on interest rates

and asset prices. Their investments enjoy full capital account convertibility.

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4.2.4. Introduction of Depository Receipts

The process of integration received a major impetus when the Indian corporate

was allowed to go global with the issue of GDR/ADR/FCCB1 from November 1993.

While bunching of Depository Receipts (DRs) issues took place in view of the pent-up

overseas demand for Indian securities, it was primarily motivated by the costly

procedure of floatation in the domestic market (Patil, 1994). Initially, companies

seeking to float DRs were required to obtain prior permission from the Department of

Economic Affairs. To be eligible, companies should have a consistent track record of

good performance for a minimum of three years. The infrastructure companies were

exempted from the latter requirement in June 1996. The restrictions on number of DR

issued were also removed along with it. The end-use restrictions on Euro issues were

removed in May 1998. In December 1999 Indian software companies, in March 2000

other knowledge-based companies, and in April 2001 all types of companies were

permitted to undertake overseas business acquisition through ADR/GDR stock swaps.

In January 2000, companies were made free to access the GDR/ADR market through

an automatic route operated by the RBI, without the prior approval of the Government

of India or the track record condition. Similarly, companies were allowed in phases to

utilise, without any prior approval, part of the DR proceeds for overseas investment

and finally upto 100 per cent of the proceeds from February 2001.

DRs can be redeemed at the price of the corresponding shares of the issuing

company ruling on the BSE or NSE on the date of redemption. Similar norms apply

to conversion of FCCBs. The ordinary shares and FCCB issued against the DRs are

treated as foreign direct investment (FDI). The aggregate of foreign equity

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participation directly or indirectly through the DR mechanism should not exceed 51

per cent of the issued and subscribed capital of the issuing company. Two-way-

fungibility in DR issues of Indian companies has been introduced from February 13,

2002 whereby converted local shares could be reconverted into DR subject to sectoral

caps on FDI. Interest payments and dividend on these instruments are subject to tax

deduction at source at the rate of 10 per cent. Capital gains on account of transactions

among non-resident investors outside India are free from any income tax liability in

India

4.2.5. Introduction of Depository System

For modernising the settlement system the Depositories Act was passed in

1996, which provided for the establishment of depositories in securities. The objective

of this Act is to reduce settlement risk arising out of bad delivery, the time taken for

settlement and due to the physical movement of paper. It aims at de-materialisation of

securities in the depository mode and providing for maintenance of ownership records

electronically in a book entry form. The Act also envisages transfer of ownership of

securities electronically by book entry with making securities move from person to

person. Accordingly two depositories were set up in the country, viz. the National

Securities Depository Limited (NSDL) and the Central Depository Services Limited

(CDSL), to provide instantaneous electronic transfer of securities. It has been now

made mandatory that all new securities issued should be compulsorily traded in de-

materialised form. The admission to a depository for de-materialisation of securities

has been made a pre-requisite for making a public or rights issue or an offer for sale. It

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has also been made compulsory for public limited companies making Initial Public

Offer of any security for Rs. 10 crore or more only in dematerialised form.

4.2.6. Derivatives Trading

The suggestion to introduce derivative trading in Indian securities market was

first made by the L.C. Gupta committee (1998). It suggested the introduction of

derivatives in order to assist market participants to manage risks better through

hedging, speculation and arbitrage. Accordingly, the Securities Contracts (Regulation)

Act was amended in 2001 to introduce derivative trading in NSE and BSE. The

market presently offers index futures and index options on S&P CNX NIFTY, CNX

IT Index, CNX Bank NIFTY Index, and BSE 30 Index. Stock futures and stock

options on individual stocks and futures in interest rate products like T-bills and bonds

are also introduced.

4.2.7. Demutualisation of Stock Exchanges

Traditionally, stock exchanges were organised in the form of clubs, with the

ownership and control vested with the brokers. In case of disputes, often the interests

of the brokers alone are protected, leaving the investors at the losing end. Therefore to

reduce the dominance of trading members in the management of stock exchanges, the

Government proposed to corporatise the stock exchanges by which ownership,

management and trading membership would be segregated from one another. Of the

24 stock exchanges of the country, only two stock exchanges, i.e. OTCEI and NSE are

de-mutualised. A few exchanges have started the de-mutualisation process.

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4.2.8. Risk Management Mechanism

With a view to avoid any kind of market failures, the stock exchanges have

developed a comprehensive risk management system, which is constantly monitored

and upgraded. It encompasses capital adequacy of members, adequate margin

requirements, limits on exposure and turnover, indemnity insurance, on-line position

monitoring and automatic disablement. To eliminate the counter-party risk that arises

from electronic trading, the NSE set up a clearing corporation, the National Securities

Clearing Corporation (NSCCL) in 1996. The NSCCL assured the counter-party risk of

each member and guaranteed financial settlement. NSCCL established a Settlement

Guarantee Fund to provide a cushion for any residual risk and operated like a self-

insured mechanism wherein members contribute to the Fund. In the event of failure of

a member to meet his obligations, the fund is utilised to the extent required for the

successful completion of the settlement. This has eliminated counter-party risk of

trading on the exchange.

4.2.9. Investor Protection Measures

Investors in securities market have been facing serious problems in view of

market disturbances arising out of the inefficiencies of the system. Hence, the SEBI

Act entrusted SEBI with the primary objective of protecting the interests of investors

in securities and empowered it to achieve this objective. The Central Government has

established a fund called Investor Education and Protection Fund in October 2001, for

the promotion of awareness amongst investors and protection of the interest of the

investors. Department of Economic Affairs (DEA), Department of Company Affairs

(DCA), the SEBI and the stock exchanges have set up investor grievance cells for

76

redressal of investor grievance. The exchanges maintain investor protection funds to

take care of investor claims. The DCA has also set up an investor education and

protection fund for the promotion of investors’ awareness and protection of interest of

investors. All these agencies and investor associations are organizing investor

education and awareness programmes. In January 2003, SEBI launched a nation-wide

Securities Market Awareness Campaign that aims at educating investors about the

risks associated with the market as well as the rights and obligations of investors.

4.2.10. Introduction of Rolling Settlement

Indian stock market in the early nineties used ‘future-style settlement’ with

fortnightly settlement cycle. Often, this cycle was not adhered to and on several

occasions led to defaults and risks in settlement. Besides, a peculiar market practice

called badla allowed brokers to carry positions across settlements. In other words,

even open positions at the end of the fortnight did not always get settled. In order to

reduce large open positions, SEBI over a period reduced the trading cycle to a week.

Stock exchanges, however, continued to have different weekly trading cycles, which

enabled shifting of positions from one exchange to another. Rolling Settlement was

introduced by SEBI for the first time in 1998 by making it optional for demat scrips.

Rolling settlement on T+5 bases was introduced in 2000 with respect of specified

scrips reducing the trading cycle to one day. All scrips moved to rolling settlement

from December 2001. The settlement period has been reduced progressively fromT+5

to T+3 days. Currently, T+2 day rolling settlement with one day trading cycle is being

followed, i.e. trades taking place over a day are settled together after two working

days.

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4.2.11. Reduction of Transaction Costs

In the pre-reforms period transaction costs in the Indian securities market was

high due to high order processing and brokerage related costs, which are caused by

entry barriers into the brokerage industry and costs of clearing and settlement. With

increased competition and free entry in the post-liberalisation period, brokerage

related costs went down. Similarly, costs relating to clearing and settlement also went

down thanks to the dematerialisation of shares and adoption of rolling settlement

system. For those who use the services of NSDL, transaction costs have come down

to one-tenth of previous levels, which is comparable to those seen on the best markets

overseas.

4.3. Trends and Patterns in Indian Stock Market

4.3.1. Participation of Investors

In spite of the massive rise in the activities of the stock market in the

1990s, there has not been any corresponding rise in the participation rate of individual

investors in the country. Yet there has been a nominal rise in the number of share

owning individuals from 4.5 lakhs in 1955 to 2.4 million in 1980, nine million in 1990

and further to 16 million in 1995. It further increased to 21 million in 2000. Even

though, the number in absolute terms is quite large, it accounts for only two per cent

of the total population of the country, which is quite low when compared to that of

advanced countries. Further, a survey of Indian investors conducted by SEBI

estimated that only 7.4 per cent of all Indian households have directly invested in

equity shares or debentures, or both during 2000-01(SEBI-NCAER). Of this the

number of debenture owning households and individual debenture holders far exceeds

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household and individual equity investors. This excessive reliance on debt instruments

is attributed to the investors urge to meet their long-term income flow requirements

(Tenth Five Year Plan). Another reason for poor participation rate is the lack of

investor confidence in stock market investment. The investors have been facing

serious problems in view of market disturbances arising out of unscrupulous practices

followed by many companies and market intermediaries.

Table - 4.4

Growth of Share Owning Population in India

Estimated number As a proportion

Year (in lakhs)

of population

1955 4.5 0.12

1961 6.25 0.14

1975 12 0.2

1980 24 0.36

1985 60 0.81

1990 90 1.09

1995 160 1.77

2000 210 2.08

Source: SEBI Handbook of Statistics, 2005,

The survey also observed that the number of non-investing households in the

country has increased from about 156 million in 1998-99 to 164 million in 2000-01,

constituting nearly 92.6 per cent of total households. In this environment it is the

responsibility of all the participants in the securities market to try to restore the

confidence of investors. The companies have the responsibility of establishing their

capacity to utilise funds effectively and productively, to inspire the confidence of the

investors. Problems regarding thin trading and lack of liquidity, which repels investors

79

form the stock market also need to be addressed urgently (Patel Committee, 1984 and

Pherwani Study Group, 1991). The Pherwani Study Group has observed that stock

exchanges must provide the environment and infrastructure to ensure adequate

liquidity to enable the investor to liquidate his securities without loss.

4.3.2. Dependence on Securities Market

Since 1990s the securities market in India has emerged as a major source of

finance for trade and industry. In the early 1990s the corporate sector increasingly

depended on external sources, especially equity finance, for meeting its financial

requirements. The increase in the external finance available to the corporate sector

through the capital market enabled the corporates to replace internal funds during this

period. A decline in corporate profitability in the mean period also contributed to the

increase in the corporate dependence on external finance (Nagaraj, 1996). The

contribution of capital market and equity as a source of finance peaked in 1994.

However, the importance of equity finance has declined significantly since 1995.

Debenture and bonds have become more important as a source of finance after 1995

(Pal, 2001).

The dependence of state and central governments on the securities market

increased over the past decade. About 56 per cent of the fiscal deficit of the central

government during 2003-04, has been financed through borrowings from the securities

market. However, the household sector, which accounts for 86 per cent of the gross

domestic savings of the country, invested only 5.9 percent in securities market during

2003-04. Of which 4.5 per cent is invested in fixed income bearing government

securities. So far as the domestic saving mobilization is concerned, Indian stock

80

market development has not played any prominent role, particularly with respect to the

savings of the household sector (Nagaishi, 1999). The increase in the proportion of

financial savings in household savings in the early 1990s was mainly due to portfolio

substitution by households form bank deposits to stock market instruments, and not

because of additional savings mobilisation by the stock market. It is evident from the

fact that there has not been any corresponding increase in the gross domestic savings

of the country irrespective of the increased stock market activities since 1990s

(Nagaishi,1999).

Table - 4.5

Dependence on Securities Market

Share (%) of Securities Market in

Year External Finance

of Corporates Fiscal Deficit

of Central Govt.Fiscal Deficitof State Govt.

Financial Savingsof Households

1990-91 19.35 17.9 13.6 14.4

1994-95 44.99 36.2 14.7 12.1

1998-99 27.05 60.9 14.1 4.2

2000-01 31.39 61.4 13.8 4.3

2001-02 20.60 69.4 15.2 8

2002-03 17.98 77.6 19.9 5.9

2003-04 N.A. 64.9 38.6 11.4

2004-05 N.A. 65.8 27.3 N.A. Source: NSE-ISMR, 2005, pp.6

4.3.3. Progress of Dematerialisation

SEBI has been taking serious efforts to accelerate the process of

dematerialisation, ever since the passing of the Depositories Act in 1996. Two

81

depositories viz. NSDL and CDSL provide instantaneous electronic transfer of

securities. Although the investors have a right to hold securities in either paper or

demat form, SEBI has made it compulsory that trading on securities should be only in

dematerialised form. This was initially introduced for institutional investors and was

later extended to all investors. The admission to a depository for dematerialisation of

securities has been made a pre-requisite for making a public or rights issue or an offer

for sale. The securities of listed companies, which fail to establish connectivity with

depositories within the scheduled date, are traded on the ‘trade for trade’ settlement

window of the stock exchanges.

Table - 4.6

Progress of Dematerialisation at NSDL

Parameters of progress 1999-2000

2000-01

2001-02

2002-03

2003-04

2004-05

Companies–Agreement signed 918 2821 4210 4803 5216 5536

Companies Available for D-mat 821 2786 4172 9761 5212 5536

Number of DPs 124 186 212 213 1719 216

Number of Depository Locations 1425 1896 164 1718 8369 2819

D-mat Quantity (in Cr.) 1550 3721 5167 6876 8369 N.A.

Source: SEBI Hand Book of Statistics, 2005, pp.45, NSE-ISME, 2005, pp.84

At the end of March 2004, the number of companies connected to NSDL and

CDSL were 5,212 and 4,720, respectively (Table-4.4., 4.5.). The number of

dematerialised securities have increased from 76.9 billion at the end of March 2003 to

97.7 billion at the end of March 2004. During the same period the value of

dematerialised securities has increased from, Rs. 5,875 billion to Rs. 10,701 billion.

82

Since the introduction of the depository system, dematerialisation has been

progressing at a fast pace in the country.

Table - 4.7

Progress of Dematerialisation at CDSL

Parameters of progress 1999-2000

2000-01

2001-02

2002-03

2003-04

2004-05

Companies–Agreement signed 541 2723 4293 4628 4810 5068

Companies Available for D-mat 541 2703 4284 4628 4810 5068

Number of DPs N.A. 137 148 177 200 532

Number of Depository locations N.A. 132 181 212 219 1530

D-mat Quantity (in Cr.) N.A. 192 482 821 1401 N.A. Source: SEBI Hand Book of Statistics, 2005, pp.45, NSE-ISMR, 2005, pp.84

4.3.4. Trends in Transaction Costs

Reduction of transaction cost is a central input towards obtaining stock market

efficiency. Transaction cost is determined by costs incurred at various stages of

transaction of securities viz. trading, clearing and settlement. Stock trading involves

costs like intermediation fees paid to brokers and market impact costs. Market impact

cost is the difference between the ideal price of a security (bid+ask/2) and the deal

price. The larger the spread between bid and ask, the greater shall be the market

impact cost. It is particularly important for large transactions. Market impact cost

reflects the innate economic cost of liquidity services of the market. The market

impact cost was as high as 0.75 per transaction in 1994, which came down to 0.25 in

the year 2000. If clearing of securities works perfectly, buyers who have made

payment get securities and sellers who have supplied securities get funds. In this

process the buyer and the seller are exposed to the credit risk of each other. If one

83

party makes a default, the other may experience losses. This counter party risk was

present in Indian equity market for a long time, causing payment crises and other

severe problems. However, with the setting up of clearing corporations the counter

party risk could be eliminated from the equity market of the country (Shah, 1999).

Under the physical trading system, the settlement of securities too incurred some kind

of transaction costs, mainly in the form of the costs of bad delivery, paper works and

transaction taxes like stamp duty, service tax on brokerage and the SEBI transaction

fee. Now in demat trading all these components of transaction costs have been

eliminated from the market.

Table - 4.8

Transaction Costs in Indian Stock Market (In %, for a one-way transaction)

Source: SEBI Hand Book of Statistics, 2005, pp.105.

India Component 1994 2000

Best in the World (2000)

Trading Fee to intermediaries 2.5

0.75 0.25 0.25

0.25 Market impact cost 0.2

Clearing Counter party risk present 0 0

Settlement Paper work 0.75 0.1 0 Bad paper risk Stamp duty

0.5 0.25

0 0

0 0

Total >4.75 0.6 0.45

4.3.5. Trends in Market Outcome

Trading volumes in the equity segments of the stock exchanges have witnessed

phenomenal growth in the post-reform period. Aggregate turnover on all stock

exchanges in India registered steady growth from 1991-92 till 2001-02. There

84

experienced a slump during 2001-02 due to reasons like the withdrawal of deferral

products, and a shift from account period settlement to rolling settlement. However,

the market recovered in 2002-03, where the trading volume increased to 8.16 per cent

over the previous year. Regarding the contribution of various stock exchanges towards

turnover, most of the exchanges showed large scale declines in their turnover in the

year 2004-05. Many exchanges did not report any turnover during the whole fiscal.

Only three exchanges, viz. the NSE, BSE and Calcutta Stock Exchange showed

growth trends in turnover during this period. NSE consolidates its leading position by

contributing about 68.4 per cent of total turnover.

The market capitalisation also increased at a compounded rate over a period

of 15 years. It rose from Rs. 1, 19,297 crores in 1990-91 to Rs. 43,143,322 crores in

2003-04. As a percentage of GDP, the market capitalisation grew from a mere five per

cent in 1980s to 14 percent in 1990s and further to 25.7 per cent in 2002. The turnover

ratio, which was around 51 per cent in 1993-94 increased to 178 per cent by 1999. A

notable feature of market capitalisation in recent years is the change in the share of

different sectors in total market capitalisation. Sectors like manufacturing, constituted

35 per cent of total market capitalisation during 1998-99 have shown declines since

2001.However, it rebounded in 2004-05. Other two prominent sectors in terms of

market capitalisation are pharmaceutical and IT.

4.3.6. Trends in Equity Returns and Volatility

Return from stock market exhibited a rising trend, especially since the 1990s as

a result of broadening and deepening of the capital market. The rate of return (capital

appreciation plus dividend) for most of the indices increased for longer holding

85

periods. However, for shorter holding periods returns are not very attractive since the

probability of incurring loss is very high (Gupta and Choudhury, 2000). The capital

appreciation component of rate of return, which embodies the performance of share

prices, has contributed to the bulk of the rise in internal rate of return from equities.

Equity volatility, which shows the risk of investing in the stock market, came

down significantly compared to the 1990s. From 1995 onwards volatility exhibited

steady decline, thanks to the introduction of anonymous electronic trading system.

Volatility, measured as the twelve month rolling standard deviation of daily market

returns, is a matter of concern for investors and policy makers around the world. High

level of volatility is often looked upon as a reflection of low levels of stability of

financial markets and the economy as a whole. When compared to advanced countries,

stock market volatility is higher in emerging markets. However, India exhibits lowest

variation in stock returns among the emerging markets. Indian stock market provides

high rate of return and exhibits comparatively moderate volatility which approximates

to normal distribution (Raju & Ghosh, 2004).

The post- reform period in India is a more stable period for equity returns.

Since the introduction of electronic trading, there has been a particularly sharp decline

in the volatility of equity market in the country. The volatility of two major stock

indices of the country viz. BSE Sensex and S&P CNX Nifty came down significantly

as a result of cautious efforts by the regulator (Figure-4.1 and 4.2). Since 1999, SEBI

took a number of measures like imposition of price bands, and application of circuit

filters. The price limits were first introduced in NSE in 1995, and were subsequently

enforced on all stock exchanges by SEBI policy. Accordingly, the price of any scrip

86

was not allowed to move beyond ten per cent in a day and 25 per cent in the weekly

trading cycle. The price bands were revised to eight per cent in a day to provide

flexibility to the market and the weekly band was abolished. Circuit filters were

introduced as a market wide approach to manage volatility by stopping trading in the

entire market during normal business hours, if price movements exceed a particular

limit. The circuit filters were revised by SEBI to allow price movements to either

direction to the extent of 16 per cent in a day.

4.3.7. Pattern of Market Concentration

High market concentration or the share of total turnover of the stock exchange

accounted for by the ‘N’ largest stocks adversely affects the efficiency of the stock

market. In developed capital markets, the measure of market concentration is very low

when compared with emerging markets. However, the concentration of trading is

decreasing in India in recent years. It is observed that the share of trading among top

‘N’ scrips in turnover has reduced in both BSE and NSE over the past few years. In

NSE trading in top ‘10’ scrips accounted for about 92 per cent of the turn over during

1996-97. It has come down to 44.9 per cent in 2003-04. In BSE, trading in top ‘10’

shares accounted for 81.7 per cent of the turn over during 1996-97, which came down

to 43.6 in 2003-04. However, turnover in India seems to be more concentrated than

market capitalistion. While ten most active scrips accounted for 54 per cent of

turnover in 1999, it accounted for only 31 per cent of market capitalisation. Similarly,

in terms of index stock’s share of total market capitalistion, India position is better

than many advanced capital markets.

87

Figure - 4.1

Monthly Volatility of BSE SENSEX (April 1994- March 2005)

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5A

pr-9

4

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

AP

RIL

OC

T

Compiled from various issues of Handbook of Statistics, SEBI

Figure - 4.2

Monthly Volatility of CNX NIFTY (April 1994- March 2005)

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

Apr-

94

SE

PT

FEB

JULY

DEC MA

Y

OC

T

MAR

C

AU

G

Jan-

JUN

E

NO

V

APR

IL

SE

PT

FEB

JULY

DEC MA

Y

OC

T

MAR

C

AU

G

3-Ja

n

JUN

E

NO

V

APR

IL

SE

PT

FEB

Compiled from various issues of Handbook of Statistics, SEBI

88

Table - 4.9

Percentage Share of Top ‘N’ Securities in Turnover in Cash Segment

BSE NSE

YEAR 10 25 50 100 10 25 50 100

1996-97 81.7 88.1 91.1 93.4 92 95.7 97 98.2

1999-00 55.1 77.8 87.3 93 59.2 82.3 88.7 93.7

2001-02 43.9 66.2 81.7 91.5 62.9 82.2 91.6 95.9

2002-03 53.3 74.4 86.2 93.3 55.4 77.8 89.2 95.4

2003-04 43.6 60.9 74.5 85.9 44.9 64.3 79.5 91.1

Source: SEBI Hand Book of Statistics 2005, pp.32

4.3.8. Trends in Institutional Investment

Institutional investment in the stock market consists of investments by mutual

funds and foreign institutional investors. The mutual fund industry was monopolised

by the Unit Trust of India till the year 1987. In 1987, the banks and financial

institutions were allowed to set up mutual funds as subsidiaries. Further, private

financial institutions were allowed to enter the mutual fund industry since 1992-93.

Since then there has been a remarkable growth in terms of the number of schemes

offered, the number of holding accounts and the amount of investible funds. The bulk

of the mutual fund asset is debt securities. The net transaction of mutual fund industry

in the stock market has increased from Rs. 2257 crores in 2001 to Rs. 24009 crores in

2003-04. Foreign Institutional Investors were allowed to invest in the Indian capital

market securities from September 1992. However, investments by them were first

made in January 1993. Today there are 540 registered foreign institutional investors

operating in the country. Net investment in equities by FII registered consistent growth

89

since1992. Only in the year 1998-99, FII outflows exceeded total inflows. Net FII

investment is estimated at Rs. 44000 crores in 2003-04, which accounts to almost 96

per cent of the total foreign portfolio investment flows to the country. Though the

volume of trades by FII is not relatively very high, they are the driving force in

determination of market sentiments and price trends since their trades are delivery

based and their assessments about the market are believed to be infallible. They also

have an impact on stock market behaviour mainly through effects on interest rates and

asset prices. Data on trading activity of FIIs and domestic stock market turnover

suggests that FIIs have emerged as the most dominant investor group in the Indian

stock market (Pal, 2005).

As on April, 2006, there are 898 registered foreign institutional

investors operating in the country. Their net investment in equities registered

consistent growth since1993. Only in the year 1998-99, FII outflows exceeded total

inflows. Net FII investment in equities is estimated at Rs. 191662 crores as on April,

2006, which accounts to almost 96 per cent of the total foreign portfolio investment

flows to the country. The FII investment in India, as a percentage of market

capitalisation, has been improving steadily. It ranged between 8 to 10 percent during

the period 2002-2004. Data on trading activity of FIIs and domestic stock market

turnover suggests that though they attribute to only 15 percent of the total stock

market turnover, FIIs have emerged as the most dominant investor group in the Indian

stock market (Pal, 2005). It is found that the concerted invasion of domestic and

foreign institutional investors along with other variables account for 96 per cent

variation of Sensex in recent years (Roy, 2001).

90

Table- 4.10

Net Investments by FIIs in Indian Capital Market (In Rs.Crores)

YEAR FII NET INVESTMENT

1992-93 4.27

1993-94 5444.6

1994-95 4776.6

1995-96 6720.9

1996-97 7386.2

1997-98 5908

1998-99 -729.11

1999-00 9765.13

2000-01 9682.52

2001-02 8272.9

2002-03 2668.9

2003-04 44000.03

2004-05 40990.9

Source: SEBI Hand Book of Statistics 2005, pp.37

4.4.Regulatory Framework of Indian Stock Market

Financial market requires close monitoring and supervision, thanks to its

special characteristics. The most important of these is the large volume of transactions

and the speed with which financial resources can move from one market to another.

Besides, financial markets are often associated with negative externalities. A failure in

any one segment of these markets may affect all other segments of the market,

91

including the non-financial markets. Inv view of the externalities, volatility and certain

other special characteristics, financial markets require an efficient and separate

regulatory and supervisory framework (Jalan, 2002). The regulatory framework of the

Indian securities market consists of four fundamental legislations governing the

securities market viz. the SEBI Act, 1992, the Securities Contracts (Regulation) Act,

and the Depositories Act, 1996. The Government and the Securities and Exchange

Board of India (SEBI) have framed rules and regulations under these legislations for

registration and regulation of the market intermediaries and for prevention of unfair

trade practices (ISMR, 2005).

4.4.1. The Companies Act, 1956

It deals with the issue, allotment and transfer of securities and various aspects

relating to company management. It provides for standards of disclosure in the public

issues, particularly in the fields of company management and projects, information

about other listed companies under the same management and management perception

of risk factors. It also regulates underwriting, the use of premium and discounts on

issues, rights and bonus issues, payment of interest and dividends, supply of annual

reports and other information.

4.4.2. The Securities Contracts (Regulation) Act, 1965 (SCRA)

The Securities Contracts (Regulation) Act of 1965 gives the Central

Government for virtually all aspects of the securities trading including the running of

stock exchanges with an aim to prevent undesirable transactions in securities. It gives

the Government regulatory jurisdiction over (a) stock exchanges through a process of

recognition and continued supervision, (b) contracts in securities and (c) listing of

92

securities on stock exchanges. A stock exchange should comply with the requirements

prescribed by the Central Government for getting recognition for trading.

4.4.3. The SEBI Act, 1992

The SEBI Act enacted in 1992, empowered SEBI with statutory powers for (a)

protecting the interests of investors in securities, (b) promoting the development of the

securities market, and (c) regulating the securities market. Its regulatory jurisdiction

extends over corporates in the issuing of capital and all intermediaries and persons

associated with securities market. SEBI can conduct enquiries, audits and inspections

of all concerned participants and adjudicate offences under this Act. It has powers to

register and regulate all the market intermediaries. Further, it can also penalise them in

case of violations of the provisions of the Act, Rules and Regulations made there

under. SEBI has full autonomy and authority to regulate and develop an orderly

securities market.

4.4.4. The Depositories Act, 1996

It provides for the establishment of depositories for securities to ensure

transferability of securities with speed, accuracy and security. For this, three

provisions have been made: (a) making securities of public limited companies freely

transferable subject to certain exceptions, (b) dematerialising the securities in the

depository mode, and (c) providing for maintenance of ownership records in a book

entry form, In order to streamline the settlement process, the act envisages transfer of

ownership of securities electronically by book entry with out moving the securities

physically.

93

4.4.5. High Level Committee on Capital Markets

The responsibility for regulating the securities market is shared jointly by

Department of Economic Affairs (DEA), Department of Company Affairs (DCA),

Reserve Bank of India (RBI) and SEBI. The activities of all these agencies are

coordinated by a High Level Committee on Capital Markets. Most of the powers

under the SCRA are exercisable by DEA while a few others by SEBI and some are

concurrently by them. The regulation of the contracts for sale and purchase of

securities, gold related securities, money market securities and securities derived from

these securities and ready forward contracts in debt securities are exercised

concurrently with the RBI. The SEBI Act and the Depositories Act are mostly

administered by SEBI. While the rules under the securities laws are framed by

government, regulations are framed by SEBI. The powers under the Companies Act

relating to issue and transfer of securities and non-payment of dividend are

administered by SEBI in case of listed public companies and public companies

proposing to get their securities listed.

4.4. Structure and Working of Stock Exchanges in India

Stock Exchanges continue to be the most important service institutions in the

securities market in India. Since the regulatory framework of the country virtually

bans trading activity outside the stock exchanges, they, along with a host of

intermediaries, provide the necessary platform for trading in equities and also for

clearing and settlement of trades. At present, there are 24 stock exchanges in the

country, of which 21 exchanges are regional exchanges and others are national

94

exchanges (OTCEI, NSE and ICSE). The latest in the list- The Capital Stock

Exchange, Thiruvananthapuram, is yet to commence its operations.

4.4.1. Organisation of Stock Exchanges

Stock exchanges in India need to be registered under the Securities Contracts

(Regulation) Act, 1956. Under the SCR Act, an exchange is defined as any body of

individuals, whether incorporated or not, constituted for the purpose of assisting,

regulating or controlling the business of buying, selling or dealing in securities. Of the

24 registered stock exchanges, three (Bombay, Ahamedabad and Madya Pradesh) are

organised in the form of Association of Persons, while the rest are organised as limited

companies. Except NSE, all exchanges are not-for-profit making organisations.

Traditionally, stock exchanges in India were organised in the form of clubs, with the

ownership and control vested with the brokers. Of the 24 stock exchanges of the

country, only two stock exchanges, i.e. OTCEI and NSE are de-mutualised. The

Government has appointed a committee under the chairmanship of Chief Justice M.H.

Kania, to review the present structure of stock exchanges and to examine the legal,

financial and fiscal issues related to the demutualisation of stock exchanges. The

Committee has recommended a uniform model of demutualisation and corporatisation

and advised stock exchanges to initiate the process of getting demutualised (NSE-

ISMR, 2004).

4.4.2. National and Regional Stock Exchanges

Until recently, the area of operation of an exchange was specified at the time of its

recognition, which in effect precluded competition among the exchanges. Stock

exchanges, which have monopoly in the respective cities where they are established,

95

are called regional exchanges. Where as national exchanges are mandated to have

nationwide trading. The first exchange to provide nationwide trading was the Over the

Counter Exchange of India (OTCEI) formed in 1990. It was set to meet the long felt

need for a second tier stock market where companies with small paid up capital can

have the advantage of listing. Companies listed on the OTCEI enjoy the same status as

companies listed on and other stock exchange in the country as regards to taxes and

interest on borrowings. NSE incorporated in 1992, was the second national exchange

which provides nation-wide stock trading. Regional exchanges were established

across the length and breadth of the country to enable investors to access the stock

market. Till recently, it was mandatory for a company to list with the local stock

exchange nearest to their registered office. However, this restriction has been removed

and the companies today have an option to choose from any one of the existing stock

exchanges in India to list their securities. Regional exchanges are now free to expand

their operations to any other geographical location of its choice. Accordingly, many of

them have already expanded trading terminals to different parts of the country. With

the increased application of information technology, the trading platforms of all the

stock exchanges are accessible from anywhere in the country through their trading

terminals. This has greatly expanded the reach of the exchanges to the investors.

However, the advent of nation-wide trading network of the NSE, and BSE,

and their huge liquidity and order depth of large exchanges have impacted the fortunes

of many regional exchanges and reduced their relevance (Misra, 1999). Very few

regional stock exchanges have the necessary depth or breadth to give investors the

kind of choice that the NSE or BSE can provide. The turnover on many exchanges is

96

too low that it raises doubts over the viability of operation of separate exchanges in

different cities in the long run. Only five exchanges viz. NSE, BSE, CSE (Calcutta

Stock Exchange), ASE (Ahemedabad Stock Exchange), and the UPSE (Utter Pradesh

Stock Exchange) have registered sufficient turn over in 2003-04. Of which NSE and

BSE account for 68 per cent and 31 per cent of the total turn over of the country

respectively. With fall in turn over, the financial health of the regional exchanges is

also deteriorating. While, the income of the regional exchanges is reducing, their

expenditure is increasing because of increasing administrative and maintenance costs.

Internationally, most small exchanges have either merged with larger ones, worked out

alliances or have developed niche market, which they can profitably serve. The

Committee to Study the Future of Regional Stock Exchanges chaired by G.

Anantharaman has made a number of recommendations, including the consolidation of

regional exchanges, in this regard.

With the objective of widening the market for the securities listed on their

exchanges fourteen regional stock exchanges have promoted the Inter-connected Stock

Exchange of India Limited (ICSE) in 1998. It is a national-level stock exchange and

provides trading, clearing, settlement, risk management and surveillance support to its

traders and dealers. ICSE endeavours to create a single integrated national level

solution with access to multiple markets for providing high cost-effective service to

millions of investors across the country.

97

In another attempt towards the consolidation of regional stock exchanges, BSE

Indonext is set up as a separate trading platform under the BOLT system of BSE. It is

a joint venture of BSE and the Federation of Indian Stock Exchanges (FISE), of which

eighteen regional stock exchanges are members. It has introduced single order book

for a security. BSE Indonext is intended to be a Small and Medium Enterprises (SME)

specific market. New SME companies which may not qualify for listing in BSE or

NSE can seek listing in BSE Indonext.

4.4.3. Listing of Securities

Only the securities that have listed with the stock exchange can be traded on an

exchange. Listing provides liquidity and free negotiability to securities and ensure

proper supervision and control of dealings therein. Listing of securities on the

domestic stock exchange is governed by the provisions in the Companies Act, 1956,

The Securities Contracts (Regulation) Act, 1956, the Securities Contracts (Regulation)

Rules, 1957, and the guidelines issued by the Central Government and SEBI. In

addition, they are also governed by the rules, bye-laws and regulations of the stock

exchange concerned and by the listing agreement entered into by the issuer and the

stock exchange. The exchange is required to monitor the compliance of the companies

with the listing requirements. However, many exchanges of the country are too weakly

organized to monitor compliances of listing obligation.

4.4.4. Trading of Securities

Trading of securities in a stock exchange is accessible only to its members

(brokers). An exchange can admit a broker as its member only on the basis of the

terms specified in the SC(R) A Act 1956, the SEBI Act 1992, the rules, circulars,

98

notifications, guidelines and byelaws of the concerned stock exchange. The stock

exchanges, however, are free to stipulate stricter requirements than those stipulated by

the SEBI. As of end March 2004, there were 9,368 brokers registered with SEBI.

Over the past few years, authorities are encouraging corporatisation of the broking

industry. As a result a large number of brokers and partnership firms have converted

themselves into corporates. As of end March 2004, 3787 brokers, accounting for

nearly 40 per cent of the total brokers have become corporates.

The trading on stock exchanges in India used to take place through floor-based

open outcry system. This has been changed since the introduction of screen-based

trading system in the NSE (National Exchange for Automated Trading, NEAT) in

1995. Later BSE and a number of other regional stock exchanges introduced their

own online trading mechanisms. The BSE, and most of the other regional exchanges

followed suit and they have created the Inter Connected Stock Exchange (ICSE) to

facilitate on-line trading. This has resulted in considerable reduction in the time spent,

cost and risk of error, resulting in improved operational efficiency. The new

environment of screen-based trading has greatly enhanced the price formation process

and market prices in the country today more closely reflect fundamental values than

was the case earlier (Jha and Nagarajan, 1999). It has also helped to remove many

layers of intermediation and thus resulted in lowering transaction costs for investors.

4.4.5. Clearing and Settlement of Trades

The clearing and settlement system of stock exchanges also underwent many

changes. The fortnightly settlement system has been abolished and the stock

exchanges moved to rolling settlement system on T+2 basis. The stock exchanges

99

moved to demat trading with the enactment of Depositories Act in 1996. Trading in

derivatives commenced on the BSE and NSE to assist market participants to manage

risks better through hedging, speculation and arbitrage. Further, to promote fair trade

in stock exchanges the SEBI has banned many unfair trade practices like insider

trading.

Reforms in the securities market such as the establishment and empowerment

of SEBI, market determined allocation of resources, screen-based nation-wide trading,

dematerialisation and electronic transfer of securities, rolling settlement and ban on

deferral products, sophisticated risk management and derivative trading, have greatly

improved the regulatory framework and operational efficiency of stock market in the

country. Despite these structural and operational transformations, some basic issues

related to investor protection, integration of stock market with other financial market

segments, remain unaddressed. Further, excessive reliance on debt instruments by

savers for meeting their long-term income flow requirements have affected the

availability of long- term equity capital in the country. It has also led to narrow

investor participation in equity market. A judicious mix between interest and capital

gains incomes is necessary to balance the needs of both savers and investors.

Therefore, a widening and deepening of the capital market, including equity and long-

term debt with adequate regulatory oversight is central to the process of a sustained

growth in savings and investment in the country over time.

Another noteworthy feature of present condition of Indian stock market is the

enormous funds of FIIs which now determines the market behaviour of both the major

stock exchanges. Though this has helped to increase the liquidity and depth of the

100

stock market, relying much on FII funds may lead to adversities if interest rate

differentials even out in the future. Hence, domestic capabilities in terms of increased

participation of domestic financial institutions should be built in order to sustain the

present growth rate of Indian stock market.

End Notes

1. Depository receipts are essentially equity instruments issued outside the country to non-

resident investors by authorised Overseas Depository Banks (ODBs) against the share/bonds

of domestic companies held with the domestic custodian banks. DRs issued in the U.S. and in

the rest of the world are known as ADRs abd GDRs repectively. FCCBs are meant for

subscription by non residents in foreign currency and are convertible into ordinary shares of

the issuing company.