subject: Indian Capital market [print this page] Indian Capital market Indian Capital market
INTRODUCTION
Capital markets in India have been a reflection of the country's economic growth and development over the last two decades. Bombay Stock Exchange's sensitivity index, the Sensex, has become the barometer of the Indian market. Several reports have been published by leading international agencies on the potential scope of the Indian capital markets. India's growth story has important implications for the capital market, which has grown sharply with respect to several parameters amounts raised, number of stock exchanges and other intermediaries, listed stocks, market capitalisation, trading volumes and turnover, market instruments, investor population, issuer and intermediary profiles.
The capital market consists primarily of the debt and equity markets. Historically, it contributed significantly to mobilising funds to meet public and private companies' financing requirements. The introduction of exchange-traded derivative instruments such as options and futures has enabled investors to better hedge their positions and reduce risks.
SIGNIFICANCE OF CAPITAL MARKET
The capital market and the need for the economy to grow at the projected over 8 per cent per annum, the managers of the Indian economy have been assiduously promoting the capital market as an engine of growth to provide an alternative yet efficient means of resource mobilization and allocation. The capital market acts as a brake on channeling savings to low- yielding enterprises and impels enterprises to focus on performance. It continuously monitors performance through movements of share prices in the market and the threats of takeover. This improves efficiency of resource utilaisation and thereby significantly increases returns on investment. As a result, savers and investors are not constrained by their individual abilities, but facilitated by the economy's capability to invest and save, which inevitably enhances savings and investment in the economy. Thus, the capital market converts a given stock of investible resources into a larger flow of goods and services and augments economic growth.
HISTORY OF INDIAN CAPITAL MARKETS
The history of the Indian capital markets and the stock market, in particular can be traced back to 1861 when the American Civil War began. The opening of the Suez Canal during the 1860s led to a tremendous increase in exports to the United Kingdom and United States. Several companies were formed during this period and many banks came to the fore to handle the finances relating to these trades. With many of these registered under the British Companies Act, the Stock Exchange, Mumbai, came into existence in 1875. It was an unincorporated body of stockbrokers, which started doing business in the city under a banyan tree. Sir Phiroze Jeejeebhoy was another who dominated the stock market scene from 1946 to 1980. His word was law and he had a great deal of influence over both brokers and the government. The BSE building, icon of the Indian capital markets, is called P.J. Tower in his memory.
The planning process started in India in 1951, with importance being given to the formation of institutions and markets The Securities Contract Regulation Act 1956 became the parent regulation after the Indian Contract Act 1872, a basic law to be followed by security markets in India. To regulate the issue of share prices, the Controller of Capital Issues Act (CCI) was passed in 1947. The imposition of wealth and expenditure tax in 1957 by Mr. T.T. Krishnamachari, the then finance minister, led to a huge fall in the markets. The dividend freeze and tax on bonus issues in 1958-59 also had a negative impact. War with China in 1962 was another memorably bad year, with the resultant shortages increasing prices all round. This led to a ban on forward trading in commodity markets in 1966, which was again a very bad period, together with the introduction of the Gold Control Act in 1963.
The markets have witnessed several golden times too. Retail investors began participating in the stock markets in a small way with the dilution of the FERA in 1978. The next big boom and mass participation by retail investors happened in 1980, with the entry of Mr. Dhirubhai Ambani. Dhirubhai can be said to be the father of modern capital markets. Mr. V.P. Singh's fiscal budget in 1984 was path breaking for it started the era of liberalization. The removal of estate duty and reduction of taxes led to a swell in the new issue market and there was a deluge of companies in 1985. Mr. Manmohan Singh as Finance Minister came with a reform agenda in 1991 and this led to a resurgence of interest in the capital markets, only to be punctured by the Harshad Mehta scam in 1992. The mid-1990s saw a rise in leasing company shares, and hundreds of companies, mainly listed in Gujarat, and got listed in the BSE. There was a meltdown in software stock in early 2000. Mr. P Chidambaram continued the liberalization and reform process, opening up of the companies, lifting taxes on long-term gains and introducing short-term turnover tax. The markets have recovered since then and we have witnessed a sustained rally that has taken the index over 13000.
Several systemic changes have taken place during the short history of modern capital markets. The setting up of the Securities and Exchange Board (SEBI) in 1992 was a landmark development. It got its act together, obtained the requisite powers and became effective in early 2000. This history shows us that retail investors are yet to play a substantial role in the market as long-term investors. Retail participation in India is very limited considering the overall savings of households. Investors who hold shares in limited companies and mutual fund units are about 20-30 million. Those who participated in secondary markets are 2-3 million.
Capital markets will change completely if they grow beyond the cities and stock exchange centers reach the Indian villages. Both SEBI and retail participants should be active in spreading market wisdom and empowering investors in planning their finances and understanding the markets.
PERFORMANCE OF INDIAN CAPITAL MARKET
The growth in Indian capital markets started in 1991 and has been driven by a number of regulatory reforms, liberalization, capital control norms and the continuous monitoring by the regulatory agencies. Market capitalization of companies has increased more than six-fold and trading value has more than tripled. By 2007, India had catapulted to the sixth position in the global list of countries in terms of funds raised through Initial Public Offering (IPO). A USAID report on capital markets in 2007 stated that India was able to achieve this position because of a developed regulatory environment, modern market infrastructure, steadily increasing market capitalization and liquidity, the better allocation and mobilization of resources, a rapidly developing derivatives market, a robust mutual fund industry, and increased issuer transparency.
The country's strong economic growth is changing some of India's long-term investment themes. Infrastructure and property development are booming, huge gas and oil finds are making an impact on the rupee and there has been a significant growth in both the value and volume of new listings. Just two years ago, the total amount of private equity flows, including venture capital, was US$2.2 billion. In 2006 this grew to US$7.5 billion across 299 deals.
Source: India Venture Capital Association
Between 2003 and 2008, nearly 285 companies raised capital, of which nearly 85 companies raised capital in 2007-08 alone. 2007 was by far the best year for capital markets with the Sensex breaching the 20,000-point barrier and IPOs accounting for more than Rs. 45,000 crore ($10 billion) of capital raised. However, 2008-09 reversed this trend and proved to be a difficult year throughout the globe. The Sensex shed more than 50%, falling as low as 7,900 points. India's capital markets have clearly undergone a dramatic shift in the last 10 years.
The trends in the global and Indian capital markets have a direct link to the activity levels of capital market lawyers. Indian law firms, Amarchand & Mangaldas & Suresh A Shroff & Co (Amarchand), AZB & Partners (AZB), Luthra & Luthra (Luthra) aggressively expanded their capital markets practices to cater to the upsurge in capital markets. The Indian legal market also witnessed the birth of specialized capital markets firms. S&R Associates (S&R) was established in 2005 after the majority of the team from Pathak & Associates (P&A) branched out to set up a capital markets focused firm. In 2007, Shobhan Thakore, considered by many, including Chambers, as the senior statesman of the Indian capital markets left AZB to set up Talwar Thakore & Associates.
The Indian capital markets growth story was not restricted to the Indian law firms alone as foreign law firms beefed up India practice groups by hiring Indian qualified lawyers as partners and associates and increasingly focused on India related capital markets transactions. UK and US based firms shuffled their talent across the globe and started their India practices either from their home jurisdictions or from Singapore and Hong Kong. In 2008-09, however, the capital markets teams across law firms struggled to keep themselves busy due to the effects of the sub-prime crisis. The banking crisis and Lehman's bankruptcy added to global woes. India was not far behind in supplying its share of bad news. The chairman of Satyam Computers admitted to fraud, taking the company to the verge of bankruptcy before the Government intervened. During this phase, foreign law firms found the time to further analyze their strategies for India. Some foreign law firms remained undeterred by the falling markets and continued to recruit Indian talent. For instance, Rahul Guptan, capital markets partner at Amarchand, joined Clifford Chance and shifted base to Singapore to build the India capital markets practice.
In the recession year of April 2008 - March 2009, only 21 companies were able to raise Rs. 2,271 crore ($510 million). However, fiscal year 2010 was a year where markets put the worst behind them and posted a strong growth. As the confidence in the market grew so did the capital raising activities. 108 companies filed the draft red herring prospectus (DRHP) with the Securities Exchange Board of India (SEBI). SEBI's Capital Market report of March 2010 states that of the 108 companies that approached SEBI, 38 companies have successfully raised capital with 34 companies going public and 4 companies undertaking follow-on public offers (FPO) to raise approximately Rs. 37,125 crore ($ 8.25 billion). The Qualified Institutional Placement (QIP) market was also very active with 58 companies raising approximately Rs. 41,133 crore ($ 9.14 billion). The first quarter of calendar year 2010 has already resulted in 20 successful IPOs, with India witnessing the third largest number of IPOs after US and China, based on the findings in a recent Ernst & Young report.
With such an active market, lawyers were kept busy and the capital markets teams were back in action. Companies were keen to raise capital in some form or another and bankers were keen to get the deal flow rolling. This desire for activity gave rise to the QIP as a preferred mode of raising capital. Vandana Shroff, Partner, Amarchand, says "India's growth story is well documented. Being a capital deficient country, there will continue to be a need to raise large pools of capital which can be fulfilled by approaching the capital markets in India and internationally, provided that we do see some length of stability of the international capital markets".
Bar & Bench analyses the legal side of the Indian capital markets practice and provides a set of rankings of the Indian and foreign law firms which have advised the companies and the underwriters in the capital raising process. The rankings are based on various factors such as number and value of transactions. In this report, we also bring to you the insights of leading individuals including partners at Indian and foreign law firms and in-house counsel who have experience of working in the capital markets in India.
MARKET CAPITALISATION
Market capitalisation, which indicates size of the capital market, investor confidence and discounted future earnings of the corporate sector, crossed $1 trillion (BSE stocks, March 28, 2007). Globally, the capital market is the 14th largest in terms of capitalisation. Market capitalisation ratio is expected to rise from less than 30 per cent to over 60 per cent, as in most other emerging markets.
There are diverse players in the Indian market retail investors, mutual funds and FIIs, including several sub-categories pension funds, hedge funds and investment companies. Protecting the interests of investors is difficult because those of the retail Indian investors, mutual funds and foreign investors in the market might not always converge.
STREAMLINING THE CAPITAL MARKET
The capital market has played a catalytic role in the 9 per cent growth rate the country has achieved. Unlike other markets preoccupied with increasing the number of listed companies, India needs to drastically prune the number of listed companies to ensure that only companies with traded stocks, reasonable volumes and better price discovery remain, while providing other platforms for smaller companies. Foreign listings on the NSE and the BSE must also be allowed.
SEBI's efforts at creating heightened awareness of full disclosure and transparency have succeeded only partially. This necessitates shifting to National Listing Authority, empowering investors on the lines of US class action, using information technology and public disclosure aggressively to improve surveillance, adopting a more aggressive pro-competitive policy, introducing effective and competitive securities lending system and broad-basing derivative markets.
Fundamental institutional changes have drastically reduced transaction costs and significantly improved efficiency, transparency and safety. Policies and procedures relating to fair, efficient and transparent markets, investor education, investor protection, reduction of systemic risk and exposure norms, cumulative margins and rising corporatisation of brokers have also helped. However, inadequate development of the debt market hampers accurate pricing of current and future assets, and PFs/pensions are not allowed to invest in equities.
SEBI's bill clarified the role of the Department of Company Affairs' and acquired the power to debar directors and trace and attach assets of those companies. SEBI's guidelines (effective March 2000) started Internet-broking on Indian securities to enhance transparency and reduce infirmities in Indian capital market transactions. The creation of Investor Protection Fund (October 2001) under Section 205C of the Companies Act ensures the recovery of investments if and when companies default.
The functioning of the stock market in India continues to be fraught with the danger of frauds and scandals triggered by rigging, cornering of shares and manipulation. Hence, the market must be insulated from "crises". Since such crises cause systemic damage, prevention and detection of frauds must rely heavily on market discipline, swift prosecution and effective punishment. With sustained growth, rising exports, increasing corporate earnings, rising investment rates and moderate inflation, the capital market is poised for growth.
Growth requires wide distribution of ownership of equity, both by direct participation in capital market, and indirectly, through financial institutions, such as mutual funds, pension funds and insurance companies to enhance long-term savings and facilitate long-term financing. This necessitates an efficient and transparent price discovery process with high disclosure and regulatory standards with sound liquidity and risk management. Establishment of a single clearing corporation for money, debt and foreign exchange and provision of demutualisation will widen and deepen capital markets. A robust insurance sector with higher capital base and more diverse products would generate long-term funds for investment in debt market and release resources for investment, particularly for infrastructure.
Globally, markets are governed by competition, convergence and coordination. But fragmentation exists in India. The convergence with international best practices regarding clearing and settlement, payment systems and funds transfer, governance, disclosure and transparency require removal of insider trading, information asymmetry, and inadequate and delayed information.
CONCLUTION
In the ultimate analysis, a vibrant, well-developed capital market is a function of economic growth and a reflection of the financial system. Growth and sustainability of the market require careful management of volatility risk and risk of contagion to check sudden withdrawal of highly speculative, short-term capital. There are also important issues of adroit management of liquidity risk, clearance and settlement risk, currency risk and disclosure and legal infrastructure. Leveraging India's capital market requires improved corporate governance, reduced market concentration, availability of the market capitalisation for trading and enhanced role of mutual funds. Protection of retail investors, a modernised capital market with transparent operations, a developed corporate debt market, regulatory support and development of Mumbai as an international financial hub would help deepen the stock market and make them efficient and stable.
References:
Endo, Tadashi. 1998. The Indian Securities MarketA Guide for Foreign and Domestic Investors. Vision Books. India.
