NECESSITY ‘THE MOTHER OF INVENTION’

Stock market is a market where trading of company stock, both listed securities and unlisted takes place. In the case of India its foundation was laid down almost 200 years also; some say by four Gujarati and one Parsi merchant.

Baby steps

The stock market in India dates back to the early 18^th century when the securities of East India Company were traded in Mumbai and Calcutta, during the 1840s-1860s there were only half a dozen brokers that were recognized by the banks and merchants, and 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. In 1850s with the introduction of Companies Act; joint stock companies with limited liability, trade in the real sense started, and at that time shares of banks, cotton mills and loan securities of East India Company were transacted in large volume. The boom for the cotton industry; because of the American Civil War 1860-61 which caused to cease the supply of cotton from the United States to Europe, resulted in the boom in stock as there was an unlimited demand for cotton from India and cotton exporters gained handsomely. Many new companies were started in fields such as banking, land reclamation, cotton clearing, pressing, shipping and construction. This reckless lending policy of the banks continued the market boom and this resulted in attracting many new people to the stock market. Then the inevitable happened, and the market witnessed the first shock in 1865. Through this shook the people, but the enthusiasm they felt from the stock market resulted in the establishment of a regular and liquid market for securities, developed an equity cult among the investors, and helped to make Bombay the centre of stock market. The number of brokers increased significantly during this period and stood at 250.                     

The foundation

In 1877 the Native Stock and Share Broker Association was founded by few prominent share brokers in Bombay, this was the nucleus which later became the Bombay Stock Exchange; BSE. This gave impetus to other stock exchanges to prop up, so in 1894 the Ahmadabad Share and Stock Broker Association was established, while the Calcutta Stock Exchange came into bring in 1908. Then the World War I gave impetus to the growth of stock and shares dealing as a result stock exchange stated Madras in 1920; it soon became defunct. Other stock exchanges were set in Calcutta in 1937 and in Bombay in 1938, at that time there were eight stock exchanges in India: two in Bombay, Calcutta and Ahmadabad, and one each in Madras and Lahore. Then World War II further increased the number of stock exchanges in the country – four new exchanges were set up in Ahmadabad and three were set up at Lahore.  The Uttar Pradesh Stock Exchange Limited was incorporated in Kanpur in 1940; in 1944 Hyderabad Stock Exchange was incorporated. Further two more stock exchanges were set up in 1947.

Well prepared but lacking in financial muscle

At the time of Independence India inherited a poor economy but it had one of the best formal financial market in the developing world: there were four functioning stock exchanges with clearly defined rules governing listing, trading and settlements, 1119 listed companies with the market value of capital Rs. 971 crores. However, all the stock exchanges started to suffer the aftermath of depression and most of them started withering away one after the other until 1957, when they applied to the Central Government for reorganization, which was refused, and subsequently some of them closed shop.  During the 1950s and 1960s the demands for long term funds was not significant, partly due to weak industrial base and also due to low saving rates. However, this period was characterized by the enactment of a number of basic legislations covering different aspects of the securities market like Capital Issue Control Act 1947, Securities Contract Regulation Act 1956, and Companies Act 1956. The in 1975 FERA; Foreign Exchange Regulation Act restricted the shareholding of foreign firm in joint ventures to 40% - this resulted in many well managed multinational companies to offer their equities to the public at the regulated low price during the 1970s.

Period of adjustments

By the end of 1980s the number of exchanges increased to nine with 2265 companies listed and the market value of the listed capital aggregated to Rs. 6,750 cores. This period was significant as for the first time awareness was created among the common investors about the potential of equity investment as a hedge against inflation and as a source of higher earnings compared to the other from of investments. Since the mid 1980s debentures emerged as a powerful instrument of resources mobilization in the primary market. The Mutual Fund industry was widened, by permitting banks to set up mutual funds as subsidiaries. The introduction of public sector bonds since 1985-86 imparted an additional impetus to the stock market. This period also highlighted the large scale irregularities that existed in the basic structure and operational producer of the Bombay stock exchange, as it was basically an association of brokers, and monopolized the market. Trading at the time was mainly through ‘open cry out’ 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. And the market mainly followed  fortnightly settlement cycle, in which trading was supposed to take place for a fortnight until a predetermined expiration date, open position on the expiration date only would go to actual settlement, where funds and securities were exchanged. A market practice called ‘badla’ allowed the brokers to carry position across settlement periods. These factors led to an extremely poor functioning of equity market in the early 1990s and resulted in the Indian market moving towards a radical reform programs.

Reforms leading to better market  

The malpractices of the BSE led to the emergence of several specialized institutions such as Securities and Exchange Board of India; a regulatory body, CRISIL, CARE and ICRAC; Credit rating agency, and SCHIL; as custodial service, which transformed the Indian stock market. And the result was the creation of National Stock Exchange; NSE which created an electronic market place. NSE was founded in 1992 as a tax paying company, and started trading in 1994, and within a year NSE turnover exceeded that of BSE. In 1996 NSE set up the settlement Guarantee Fund and launched indices like NIFTY; NSE 50 Index, NIFTY Junior; Midcap 50 Index, and DEFTY Index; Dollar denominated Nifty Index. A question arises why did NSE succeed over the BSE? NSE was able to exploits the situation where BSE has done extremely little in terms of using computer technology. The ownership structure of NSE was carefully constructed so that it did not suffer from the operational rigidities of public sector firm which are directly owned by government. NSE also adopted private sector wages and HR policies. Shareholders of NSE such as IDBI, UTI etc were users of securities market and stood to again from a more liquid stock market even if that hurt the interest of stock brokers. NSE faced a highly market for order flow and its success was observed daily in terms of the market share in turn over. Another point is that NSE used transaction based model, where user’s charges were imposed on transaction. NSE opened up the entry barriers into the brokerage industry and brought the brokerage industry closer to zero economic profits. The political frictions between NSE and SEBI were useful as NSE knew that their designs and operations would be subjected to stringent scrutiny by the SEBI. BSE in retaliation tried to catch up: price of a seat on BSE fell from Rs. 40 million to Rs. 10 million, and they also automated by launching screen based trading system BOLT; Bombay-on-line trading, as their answer to NSE’s computer Screen Based Trading System; SBTS, but it was never able to catch up with NSE. Another factor that led to the NSE surging ahead was its decision of embarking on the launch of equity derivative trading. The BSE tried blocking the move by using political power and were successful initially as they were delayed for five years, but BSE could do nothing when in 2000-01 NSE rolled out with it; thanks to another controversy in BSE. As a result NSE got nearly 100% share in the runaway success of equity derivatives trading, thus confining BSE to a clear second. At present BSE have around 6000 listed entities while NSE has only around 1600. And out of the 6000 listed on BSE, the top 500 contributes to about 90% of the market capitalization. NSE has a market capital of around $2.3trillion compared to BSE that has $4.9trillion. Even through BSE has almost three times the number of companies listed NSE has majority of trade. There are 23 stock exchanges in India, not including BSE. The process of reforms led to a pace of growth almost never seen previously in the Indian stock market: the S&P Fact Book 2005 ranked India 18^th in term of market capitalization and 18^th in term of total value treaded in stock exchange and 16^th in term of turnover ratio in December 2004.

More transparency     

In order to strengthen the ‘know your client’ norm and to have sound audit of transaction in Securities Market, PAN has been made mandatory with effect from January 1 2007. Indian companies are allowed to access global finance market and benefit from the lower cost of funds. They have been permitted to raise through issue of American Depository Receipts; ADRs, Global Depository Receipts; GDRs, Foreign Currency Convertible Bonds; FCCBs and External Commercial Borrowers; ECBs. Further, Indian financial system is opened up for investments of foreign funds through Non Residential Indian; NRIs, Foreign Institutional Investment; FIIs and Over Seas Corporate Bodies; OCSs. Rolling settlements is an important measure to enhance the efficiency and integrity of the securities market. Under rolling settlement all trades executed on the trading day; T and settled after certain days; N. This is called T+N rolling settlement. Since April 2002 trades are settled under T+3 rolling settlement, but from April 2003, the trading cycle has been reduced to T+2 days – this reduction has reduced the undue speculation on the stock market. The CCIL registered in 2001; under the Companies Act 1956 with State Bank of India as the Chief Promoter, clears all transitions in government securities and repos, and also Rupee/US Dollar Forex spot and forward deals all in government securities below Rs. 20 crores would be mandatory settled through CCIL, while those above Rs. 20 cores would have the option of settlement through the RBI or CCIL.        

The results of reforms

In the last few years, Indian economy is growing at a good speed, which has attracted huge inflow of Foreign Institution Investment; FIIs and the massive entry of FIIs have given good appreciation for the Indian investors. Many foreign and Indian commercial banks have set up their merchant banking division in the last few years, these provide financial services such as underwriting facilities, issue organizing, consultant services etc - have helped growing of the economy. Under the purview of the SEBI the Central Government of India has set up the Investors Education and Protection Funds; since 2001, which works at educating and guiding investors and tries to protect the interest of the small investors from frauds and malpractices in the Capital market. Along with the trading of ordinary securities, the trading in commodities is also encouraged: Multi Commodity Exchange; MCX is set up.   

Finishing thoughts

Indian capital market; working hours from 9:15 am – 3:30 pm, has endured many cuts through shocks, crashes, depressions and various malpractices and manipulative trade practices of brokers and other participants from its inception; 1875. In the recent years; mostly post 1994 Indian Stock Market is witnessing fine times; breaking milestones after milestones, thanks to many favorable conditions provided by the Government of India aided chiefly by the RBI; Reserve Bank of India, and other financial institutions. The cost is not clear a yet and attention need to be cast on the recent problems facing the Indian Stock Market, by keeping an eye on the distinct horizon.   

     

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