Chapter 41 The Indian Capital Market – Indian Economy


The Indian Capital Market


Capital is a sine qua non for economic development. Without capital land will be barren, labour idle and organizations directionless. Capital enables the entrepreneur to bring together the other factors of production. It is necessary to build and develop infrastructure, buy and put in place plant and machinery, for working capital, and for setting up markets and so on. Capital grows out of savings of the community. Capital investment would lead to economic development only if channelled into productive activity. The securities market is the channel through which investible resources are routed to companies. The securities market converts a given stock of investible funds to a larger flow of goods and services. A well-organized and efficiently functioning securities market is conducive to sustained economic growth.

In post-Independence India, especially since 1985, there has been an appreciable growth in the capital market. The Indian capital market by 1990 was one of the fastest growing markets in the world. The number of companies listed on the stock exchanges, close to 6000, was the second highest after the USA and by 1995 the number rose to 8593. Presently, there are more than 10,000 listed companies in the country’s 24 stock exchanges. Shareholding public is estimated at 30 million. Value of securities traded increased from USD 5 billion in 1985 to USD 21.9 billion in 1990, which was the fourth largest amongst the emerging markets of the world. Market capitalization increased from USD 14.4 billion in 1985 to USD 38.6 billion in 1990, USD 65.1 billion in 1992, USD 80  billion in 1993 and exceeded USD 120 billion in 1998–99. Turnover ratio (total value traded as percentage of average market capitalization) rose to 65.9. Resources raised from the capital market by the non-government public limited companies increased from INR 7063.4 million (USD 731  million) to INR 52,668.0 million in 1982–83.

Indian corporations raised domestic debt and equity totalling USD 6.4 billion equivalent in 1994–95, USD 8.5 billion in 1996–97. Indian companies have also been raising substantial sums in the international capital markets—USD 4.7 billion in 1994–95, USD 2.3 billion in 1995–96 and USD 4.7 billion in 1996–97. There has been a dramatic shift towards increased issuance of debt instruments in recent times. The equity debt split was 97 per cent to 3 per cent in 1994–95 and by 1996–97, it was 23 per cent to 77 per cent.

The Capital Market

The capital market is the market for long-term funds. It refers to all the facilities and institutional arrangements available for borrowing and lending term funds for investment purposes. Industry raises finance from the capital market with the help of a number of instruments. Broadly speaking, corporations have a choice of (i) equity finance and (ii) debt finance. Experience in different countries varies. Generally, equity-based capital is cheap and less cumbersome to manage and service. Substituting equity finance for debt finance makes domestic firms less vulnerable to fluctuations in earnings or increases in interest rates. During the last decade, more than a third of the increase in net assets of large firms in developing countries across the world has been secured through equity issuance. This pattern contrasts sharply with those of the industrial countries, in which equity financing during the same period has accounted for less than 5 per cent of the growth in net assets.

In the liberalized economic environment, the capital market plays a crucial role in the process of economic development. The capital market has to arrange funds to meet the financial needs of both public and private sector units, from domestic as well as foreign sources. What is more critical is that the changed environment is characterized by cut-throat competition. Ability of enterprises to mobilize funds at cheap rates will determine their competitiveness vis-à-vis their competitors in order to perform well in a highly competitive environment.

Capital market plays a decisive role in the growth and development of an economy. Resources would remain idle and unutilized if capital is not channelled through capital market. We can briefly summarize the importance of capital market as follows:

  1. The capital market serves as an important source for the productive utilization of the savings of the community. It helps in the mobilization of savings of the community for further investment and avoids its wastage in unproductive uses.
  2. The capital market facilitates capital formation by offering incentives for savings through attractive rates of interest.
  3. The capital market provides an avenue for investors, especially for household and retail investors, to invest in financial products that are more productive than physical assets.
  4. By providing capital which is the life-blood to industry and commerce, the capital market facilitates enhancement of production and productivity which in turn increase the national income and economic welfare of society.
  5. ‘The operations of different institutions in the capital market induce economic growth. They give quantitative and qualitative directions to the flow of funds and bring about rational allocation of scarce resources.’1
  6. ‘A healthy capital market consisting of expert intermediaries promotes stability in values of securities representing capital funds.’2
  7. Additionally, the capital market greatly facilitates technological upgradation in the industrial sector by enabling industry use the investors’ funds for that purpose.


The Indian capital market achieved further depth and width in business transacted during 2007. The Bombay Stock Exchange (BSE) Index Sensex that has been continually rising since the second part of 2003 peaked at 20,000 mark by the end of December 2007. Likewise, during the same period, the National Stock Exchange (NSE) Index too closed above the 6100 mark. Between 2003 and 2007 both the indices more than tripled and yielded handsome annual returns to investors. ‘Alongside the growth of business in the Indian capital market, the regulatory and oversight norms have improved over the years, ensuring a sound and stable market’3 during the period.

The Primary Market

The primary capital market (a market for new issues of shares, debentures and bonds) started on a growth path in 2006 and 2007 after suffering a setback in 2005. There was a 31.5 per cent growth during 2007 compared to 2006 in the total amount of capital raised through different market instruments. It is worth mentioning that during 2006 there had been a 30.6 per cent jump in the quantum of capital raised compared to the lows of 2005. By 2011–12, these had been a substantial growth in the primary capital market when it was Rs 2,03,005 crores. During 2011–12, (up to 31 December 2011), 30 new companies (initial public offers—IPOs) were listed at the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) amounting to Rs 5043 crores as against 53 companies amounting to Rs 35,559 crore listed in 2010–11. The mean IPO size for the year 2011– 12 was Rs 168 crore as compared to Rs 671 crores in 2010–11. Further, only Rs 4791 crores was mobilized through private placement in corporate debt in 2011–12 (April– December) was Rs 1,88,530 crore as compared to Rs 2,18,785 crore in 2010–11. Table 41.1 given below also illustrates resource mobilization through primary market:

Table 4.1 Resource Mobilization Through the Primary Market



Resource Mobilization by Mutual Funds

During 2011–12 (up to 30 November 2011), MFs mobilized Rs 1,00,338 crores from the market as compared to Rs 49,406 crore liquidation in 2010–11. The market value of assets under management stood at Rs 6,81,655 crores as on 30 November 2011 compared to Rs 6,65,282 crores as on 31 March 2011, indicating an increase of 2.5 per cent.

The Secondary Market

In the secondary market (where already issued and outstanding shares are bought and sold), there was a perceptible expansion of activity during 2007–08 with BSE and NSE indices scaling new peaks at 21,000 and 6300, respectively, in January 2008. The indices, of course, showed intermittent fluctuations due to changing market sentiments but their onward march was assured with larger inflows from Foreign Institutional Investors (FIIs) and wider participation of domestic institutional investors and others. ‘During 2007, on a point-to-point basis, Sensex and Nifty indices rose by 47.1 and 54.8 per cent, respectively.’4 Recently, on 31 December 2011, Indian benchmark indices, BSE Sensex and Nifty, decreased by 20.4 per cent and 20.7 per cent respectively over the closing value of 2010–11. Nifty Junior and BSE 500 also decreased by 22.6 per cent and 26.1 per cent respectively during the same period (Table 5.17 and Figure 5.3).

The free float market capitalization of Nifty, Sensex, Nifty Junior, and BSE 500 stood at Rs 14,05,066 crore, Rs 12,66,639 crore, Rs 2,47,531 crore, and Rs 21,66,947 crores, respectively, in 2011–12 (up to 31 December 2011), indicating a decrease of 20.0 per cent, 18.6 per cent, 21.8 per cent, and 22.0 per cent, respectively, over 2010–11. The vibrancy of Indian bourses was due to a combination of positive factors such as India registering the second largest GDP growth amongst countries of the world, continued increased profitability of Indian companies and consequent high dividends enjoyed by investors that boosted their sentiments, persistent difference in domestic and international levels of interest rates and a strong Indian rupee backed up by larger capital inflows.

Recent Developments

While the BSE Sensex climbed the fastest so far during 2007–08, the Sensex jump from 18,000 to 19,000 mark was achieved in just four trading sessions in December 2007 and reached an unbelievable 21,000 mark in an intra-day trading in January 2008. ‘BSE Sensex yielded a compounded return of 36.5 per cent per year between 2003 and 2007. In terms of simple average, BSE Sensex has given an annual return of more than 40 per cent during the last three years. BSE 500 recorded a compounded annual return of 38 per cent between 2003 and 2007.’5 In 2007, the assets managed by mutual funds grew by 1.7 times from INR 3270 billion during 2006, to INR 5500 billion. However, BSE and NSE indices declined sharply from the latter part of 2008 reflecting concerns on global financial developments with stock indices climbing new heights, investors’ wealth as reflected in market capitalization also rose in unison. The market capitalization in India almost doubled in 2007. One of the significant parameters to evaluate the size of the capital market is the ratio of market capitalization to GDP. In that respect, India fares well compared to other emerging markets, as well as some select markets of developed countries with BSE 500 market capitalization of USD 1638 billion which was higher than 150 per cent of GDP on 31 December 2007. Moreover, the valuation of Indian stocks as reflected in P/E multiples of approximately 27 times at end December 2007 was the highest among the select emerging market economies such as Thailand, Malaysia, South Korea and Taiwan. In another instance of growth in one of the parameters, the assets under management of mutual funds grew by 1.7 times from INR 3230 billion during 2006 to INR 5500 billion in 2007.

The sudden and dramatic events that took place in New York’s Wall Street from 7 June 2008 triggered a chain of developments in the American financial sector severely impacting the main street players as well. September 15 witnessed Wall Street’s worst day since the crisis began, when Lehman Brothers, touted as the world’s largest investment banker, filed for USA’s largest bankruptcy. It was almost a watershed in the present crisis causing a collapse of the country’s banking and financial sector in a sort of Domino effect. Initially complacent, developing countries such as India and China, which thought that they were sufficiently insulated, realized their follies in good time and followed the USA and the EU in offering stabilization packages.6

After Effects of the US Global Financial Crisis

An adverse effect of the US financial crisis was the drying up of liquidity in Indian capital market which impacted the profitability of companies and their competitiveness among the global players. The situation worsened with a depreciating rupee which made essential imports such as oil, spares and components costlier. Some Indian banks were exposed to the turmoil suffered by the US investment banks like Lehman Brothers. ICICI had to take a loss of USD 28 million and State Bank USD 10 million. They had to make provisions for this or write off these exposures or pass them on to others.

CRISIL estimated that the Indian stock market lost a whopping INR 23,000 million of shareholders’ wealth in the month of September 2008 in the wake of the financial meltdown in the USA. ‘Further global liquidity pressures affected FII investment in the country, adding to the weakness of Indian markets.’ According to the data from SEBI, the FIIs had withdrawn market funds to the tune of INR 82,780 million from Indian capital in September 2008.7 India’s forex reserves which peaked at USD 320 billion started declining by huge withdrawals by MNCs and before the US meltdown, ‘dipped by $7.87 billion to $283.941 billion for the week ended 3 October, the Reserve Bank of India (RBI) said in its weekly report’ on 10 October 2008.8

All these developments gave a feeling of tremendous pessimism about the future performance of the Indian capital market. Millions of investors, small and big, lost their confidence in it after losing their hard-earned money which they invested in it went up in smoke.

Capital Markets Pole-Vaulted on 19 May 2009

However, there was a silver lining in an otherwise gloomy sky. The announcement that the Congress-led United Progressive Alliance (UPA) had a clear mandate in the 15th Lok Sabha elections created a record-breaking surge. ‘It was a frenzy of the Indian stock market. Investors scrambled to buy stocks as if there was no tomorrow, almost certain that the emergence of a stable government at the Centre would solve all the ills dogging the economy.’9

‘The Dalal Street lost fear for the first time since the global recession hit markets with the fall of U.S.-based investment banker Lehman Brothers in August 2008. United Progressive Alliance’s near majority in parliamentary elections helped the market create history and hit the upper circuit twice in a day.’10 The mad rush for buying stocks of every kind triggered circuit breakers on the upside and BSE had to halt the trading from 12 noon onwards on that historic Monday. This was the first time in the chequered history of BSE that trading had to be suspended after upper circuit breakers were breached. Again, ‘For the first time in Indian stock market history, trading had to be halted due to a surge in the Sensex initially for two hours and then for the day-as the index soared a record-smashing 2110 points in barely a minute. The Sensex rose close to 50 per cent in 2009, making India the world’s best-performing stock market.’11 As a corollary to this sterling performance of the stock market, the rupee upped its value vis-à-vis the dollar. Rupee rose from 49.41 per dollar to 47.92, the sharpest upward movement in 23 years, taking April’s gain to 4.5 per cent, the best among the 10 most active currencies except the yen.

The stellar performance of the capital market and the rupee reflected the prevailing sentiment that a stable government at the centre lowered country risk, enhanced interest of foreign investors, enthused mutual funds and energized retail investors. It also triggered diversion from investment in gold whose prices fell by INR 400 per gram on that cataclysmic Monday. From the government’s point of view, there was a hope for fresh disinvestment, containing widening fiscal deficit, reducing government borrowing and signalling downward interest rates, good both for business and retail borrowers. The bull-run also boosted expansion plans of several large Indian companies, while the rally suggested ‘a rekindling of a hope factor, which will play an important role in the revival of the economy.’12 There were many more positive factors discernable as a result of the UPA-led stock rally. ‘The week that started with an unbelievable 17.3 per cent gain for Sensex, ended on a winning note with the weekly gain at over 14 per cent, the best for the index in the last 17 years.’13 The trading on the last working day (Friday, 22 May) of the bull-run week also added about INR 5200 billion to investor’s wealth with BSE’s market capitalization reaching INR 45,400 billion. The post-election developments have made Dalal street investors richer by over INR 7000 billion. ‘Since the results of the Lok Sabha elections were announced on May 16, BSE’s market capitalization has increased by INR 7040 billion to INR 44,800 billion now. In other words, in the last seven sessions, on an average, investor wealth has increased by INR 1000 billion.’14

Subsequently, the frenzy subsided and the market moved in tandem with global markets. According to market analysts, frontline stocks looked very much overvalued after the meteoric rise on 18 May 2009. They also predicted that the Indian markets were increasingly aligning with leading markets across the world. Once the market sentiment swayed to optimism, it was also seen that investors lapped up new equity fund offers. Most of the funds which received lacklustre offers earlier, now received favourable response post 18 April 2009 from retail investors.

Debt Market

Debt market is an important constituent of capital market. The Indian debt market has two segments: (i) Government securities market and (ii) Corporate debt market.

Government Securities Market

The government securities market, otherwise known as Gilt-edged securities market, is where government securities are traded. There are both short- and long-term markets for these securities. While long-term securities are traded in the capital market, short-term securities are traded in money market. These securities are issued by the central government, state government, and semi- government authorities such as City Corporations, Port Trusts, State Electricity Boards, and central/state-owned financial corporations, and the public sector enterprises deal in this debt market.

The fresh floating of Government of India (GoI) securities in 2007 amounted to INR 1,620  billion compared to INR 1470 billion in 2006. Their market capitalization went up to INR 13,184.19 billion by the end of December 2007 compared to INR 11,315.58 billion one year earlier.

Corporate Debt Market

In the corporate debt market, as had been the practice in the past, private placements have been dominating the mobilization of resources. ‘The yield rate on corporate primary debt papers (with AAA rating) for five-year maturity ranged between 7.26 per cent and 8.45 per cent in 2005–06, 8.43 per cent and 9.44 per cent in 2006–07 and 9.19 per cent and 10.80 per cent in 2007–08 (April-December)’.15 The market capitalization of corporate bonds rose to INR 680.74 billion at the end of December 2007 from INR 491.55 billion at end-December 2006.


The Indian capital market, like the money market, is known for its dichotomy. It consists of an organized sector and an unorganized sector. In the organized sector of the market, the demand for capital comes mostly from corporates and government and semi-government organizations. The supply comes from household savings, institutional investors such as banks, investment trusts, insurance companies, finance corporations, government and international financing agencies.

Case 41.1 Circuit Breakers

What is a circuit breaker?

The circuit breaker checks any abnormal movement in indices and stock manipulation. The breaker is applied in three stages movement—10, 15 and 20 per cent—either up or down.

How circuit limit is fixed?

A circuit limit is fixed on the basis of dosing index values at the end of the previous quarter. Monday’s limits were calculated on the basis of the closing value of Sensex and Nifty on 31 March 2009, which were 9708.5 and 3,020.95, respectively.

How does circuit breaker impact trading?

Trading is halted for an hour after an index moves 10 per cent intra-day. In case of 15 per cent movement, it is halted for 2 hours. If the index hits the 20 per cent limit, trading is suspended for the rest of the day.

What happened on Monday?

Within a few seconds after markets opened at 9.55 AM, Sensex and Nifty vaulted 1789.9 points and 531.7 points, respectively, thereby breaching circuit limits of 1450 points (15 per cent) and 450 points (15 per cent), respectively, for the two indices. Consequently, trading in both equity and derivatives segments was halted for 2 hours till 11.55 a.m. Within seconds after resuming trading, the indices soared to 2110.8 points and 651.5 points respectively, prompting the stock exchanges to apply 20 per cent circuit breaker and suspend trading for the rest of the day.

Source: ‘Circuit Breakers Check Abnormal Movement in Indices’, The Economic Times, 19 May 2009.

The unorganized sector of the capital market on the supply side consists mostly of indigenous bankers and moneylenders. While in the organized sector the demand for funds is mostly for productive investment, a large part of the demand for funds in the unorganized market is for consumption purpose. In fact, many purposes, for which funds are very difficult to get from the organized market, are financed by the unorganized sector. The unorganized capital market in India, like the unorganized money market, is characterized by the existence of multiplicity and exorbitant rates of interest, as well as lack of uniformity in their business transactions. On the other hand, the activities of the organized market are subject to a number of government controls, and of the market regulator, SEBI. Though efforts were initiated to bring the unorganized sector under some sort of regulatory framework or at least to bring in some discipline such as registration, these were not successful and this segment is by and large outside effective government control.

The organized sector has been subjected to increasing institutionalization. The public sector financial institutions account for a large chunk of the business of this sector.

Development of Capital Market

As pointed out earlier, the Indian capital market has undergone many significant changes since Independence. The important factors that have contributed to the development of the Indian capital market are given below:

  1. Legislative measures: Laws such as the Companies Act, the Securities Contracts (Regulation) Act and the Capital Issues (Control) Act had empowered the government to regulate the activities of the capital market with a view of assuring healthy trends in the markets, protecting the interest of the investor, efficient utilization of the resources, etc.
  2. Establishment of development banks and expansion of the public sector: Starting with the establishment of the Industrial Finance Corporation of India (IFCI), a number of development banks have been established at the national and regional levels to provide financial assistance to enterprises. These institutions today account for a large chunk of the industrial finance.
  3. The expansion of the public sector in the money and capital markets has been accelerated by the nationalization of the insurance business and the major part of the banking business. The Life Insurance was nationalized in 1956 and the General Insurance in 1972. The Reserve Bank in India was nationalized as early as 1949. The Imperial Bank, the then largest commercial bank in India, was nationalized and established as the State Bank of India in 1955. The 14 major private commercial banks were nationalized in 1969. With the nationalization of the six leading private banks in 1980, over 90 per cent of the commercial banking business came to be concentrated in the government sector.
  4. Thus, an important aspect of the Indian capital market is that a large part of the investible funds available in the organized sector is owned by the government. The new economic policy has changed the trend, and brought in the private sector in a large measure.
  5. Growth of underwriting business: There has been a phenomenal growth in the underwriting business, which was mainly due to the public financial corporations and the commercial banks. After the elimination of forward trading, brokers have begun to take on underwriting risks in the new issue market. In the last one decade, the amount underwritten as percentage of total private capital issues offered to public varied between 72 and 97 per cent.
  6. Public confidence: Impressive performance of certain large companies such as Reliance Industries, TISCO and Larsen & Toubro encouraged public investment in industrial securities. Booms and the consequent declaration of hefty dividends in the mid-1980s boosted investor confidence.
  7. Increasing awareness of investment opportunities: The improvement in education and communication has created more public awareness about the investment opportunities in the business sector. The market for industrial securities has become broader.
  8. Capital market reforms: A number of measures have been taken to check abuses and to promote healthy development of the capital market. The enactment of the Securities and Exchange Board of India Act, 1992 and the establishment of the Securities and Exchange Board of India (SEBI) as a capital market regulator are important milestones in the process of reforms in this sector.


The Indian capital market suffers from the following deficiencies:

  • Lack of diversity in the financial instruments.
  • Lack of control over the fair disclosure of financial information.
  • Poor growth in the secondary market.
  • Prevalence of insider trading and front running.16
  • Manipulation of security prices.
  • Existence of unofficial trade in the primary market, prior to the issue coming into the market.
  • Absence of proper control over brokers and sub-brokers.
  • Passive role of public financial institutions in checking malpractices.
  • • High cost of transactions and intermediation, mainly due to the absence of well-defined norms for institutional investment.

In a planned economy, like the one we had prior to liberalization when the stock exchanges performed a residual role, these deficiencies did not matter much. On the other hand, in a market-driven economy towards which we are moving, capital market is expected to perform multifarious and facilitative functions, such as:

  • Privatization and a greater role for the private sector imply a large demand for equity finance.
  • Equity market should enable investors to diversify their wealth across a variety of assets.
  • Stock markets should perform a screening and monitoring role.
  • • A financial system that functions well requires that the whole financial sector functions efficiently.

In view of its importance, the continuing shortcomings point to the inability of the market to function at a level that is expected.

Impact of Globalization

With the gradual opening up of the Indian economy, increasing importance of foreign portfolio investment in the market and drastic reduction in import tariffs that has exposed Indian companies to foreign competition, Indian capital market is acquiring a global image. Till recently, participants in the Indian capital market could, to a large extent, afford to ignore the proceedings in other parts of the world. Share prices largely behaved as if the rest of the world just did not exist. However, now the Indian capital market responds to all types of external developments, such as the US bond yields, the value of the euro or, for that matter, any other currency, the political situation in the Gulf or new petrochemical capacity in China.

In short, the Indian capital market is on the threshold of a new era. Gradual globalization of the market will mean the following changes:

  • The market will be more sensitive to overseas developments.
  • There will be a power shift as domestic institutions are forced to compete with the FIIs who control the floating stock and are also in control of the global depository receipts (GDR) market.
  • Structural issues will come to the fore with a plain message: ‘Either reform or despair.’
  • Individual investors in their own interests will refrain from both primary and secondary market; they will be better off investing in mutual funds.

Role of Securities Market in Economic Growth

  1. The securities market helps in the allocation to best companies: In the words of G. N. Bajpai, the erstwhile SEBI Chairman:

    It is the securities market which reflects the level of corporate governance of different companies and accordingly allocates resources to best governed companies. If the securities market is efficient, it can penalise the badly governed companies and reward the better- governed companies. Hence, not only the corporate governance standards need to improve, but also efficiency and efficacy of securities market need to improve so that the resources are directed to the deserving companies, which can really boost economic performance. The securities market cannot make best allocation of resources if the standards of corporate governance are not followed in letter and spirit.17

  2. The securities market is conducive to sustained economic growth:

    A well-functioning securities market is conducive to sustained economic growth. A number of studies, starting from World Bank and IMF to various scholars, have pronounced robust relationship not only one way, but also both the ways, between the development in the securities market and the economic growth. This happens, as market gets disciplined, developed and efficient, it avoids the allocation of scarce savings to low yielding enterprises and forces the enterprises to focus on their performance which is being continuously evaluated through share prices in the market and which faces the threat of take-over.18

  3. The securities market provides a bridge between savings and investment: Though the Classical Economists led by Adam Smith believed that over time savings would be equal to investment, it does not seem to happen in actual practice. The reason is not far to seek. The  savers are different from investors and their motives are also different. The result is disequilibrium between the two. To quote G. N. Bajpai again:

    The unequal distribution of entrepreneurial talents and risk taking proclivities in any economy means that at one extreme, there are some whose investment plans may be frustrated for want of enough savings, while at the other end, there are those who do not need to consume all their incomes but who are too inert to save or too cautious to invest the surplus productively.19

    For the economy as a whole, productive investment may thus fall short of its potential level. In these circumstances, the securities market provides a bridge between ultimate savers and ultimate investors and creates the opportunity to put the savings of the cautious at the disposal of the enterprising, thus promising to raise the total level of investment and hence growth.20

    The indivisibility or lumpiness of many potentially profitable but large investments reinforces this argument. These are commonly beyond the financing capacity of any single economic unit but may be supported if the investor can gather and combine the savings of many. Moreover, the availability of yield bearing securities makes present consumption more expensive relative to future consumption and, therefore, people might be induced to consume less today. The composition of savings may also change with fewer saving being held in the form of idle money or unproductive durable assets, simply because more divisible and liquid assets are available.21

  4. The securities market provides connectivity to the rest of the world: The securities market facilitates the globalization of an economy by providing connectivity to the rest of the world. This linkage helps the inflow of capital into the country’s economy in the form of portfolio investment. Besides, a strong domestic stock market performance will also enable well-run local companies to raise capital abroad. Some of the Indian companies like Reliance, Infosys, and many others have, for instance, successfully tapped markets abroad and secured huge amounts, a prospect unthinkable hardly a decade back or even now in the domestic market. This practice will, in turn, help raise the efficiency of domestic corporates once they are exposed to international competitive pressures and the necessity of not only surviving amidst competition but also to perform well for their continued survival.
  5. The securities market will deter capital flight to developed countries: The existence of a domestic securities market will deter capital flight from the domestic economy by providing attractive investment opportunities locally. Economists also point out that a developed securities market successfully monitors the efficiency with which the existing capital stock is deployed and thereby significantly increases the average rate of return on investment.

Regulatory Framework of the Indian Capital Market

There are four institutional regulators and one procedural requirement that constitute the regulatory framework of the Indian capital market. These are the following:

  1. The Securities and Exchange Board of India (SEBI): The SEBI Act 1992 which conferred statutory status to SEBI as a securities market regulator mandates it to perform a dual function: (a) investor protection by regulating the securities market and (b) fostering its growth. Apart from the power to register and regulate intermediaries, it also enjoys the power to issue directives to participants and inspect books and records. It has the power to suspend registered entities and cancel registration, if so required.
  2. Reserve Bank of India (RBI): RBI has a certain degree of regulatory involvement in the capital market such as debt management through primary dealers, forex control and liquidity support to market participants. Besides, RBI has the power to permit or deny permission for securities transaction that involves a foreign exchange component.
  3. Department of Corporate Affairs (DCA): The DCA under the Ministry of Finance, GoI, governs certain aspects of company affairs under the aegis of the Companies Act, 1956. Apart from the formation, management, mergers and liquidation of companies, the Act covers certain issues relating to capital issuance and securities trading including the issue of Prospectus for IPOs, contents thereof, allotment, transfer and registration of securities.
  4. Stock Exchanges: The SEBI has stipulated as to who should be in the governing boards of stock exchanges. Every stock exchange has a SEBI nominee, who is part of half of the non-broker public representatives in the governing boards. Matters of discipline, default and disputes arising between brokers and investors are looked into by committees with a majority of non-brokers. Stock exchanges should have a machinery to settle investor grievances fast. The SEBI stipulates that every stock exchange should have an executive director, who is a non-member and who is ‘accountable to SEBI for the implementation of its directives’.22
  5. Public Disclosure: Every company that goes in for issue of securities has to make a public disclosure of all relevant information through its offer documents such as:
    • Prospectus
    • Abridged version of the Prospectus for public issues with an application form
    • Letter of offer to existing share/debenture holders with a proxy option

Once the security is issued and listed in a stock exchange, a company should provide the following information as a part of the Listing Agreement:

  • The date of the board meeting for corporate actions
  • The financial results, duly audited and submitted during specified time
  • Any change proposed either in the nature or general character of the company’s business
  • Any change in the company’s capital structure
  • • Any change to be effected in the company’s auditor and the members of the Board, including those of managing directors

Despite their deficiencies, the Indian capital market including stock exchanges play a crucial role in purveying funds to industries. The Bombay Stock Exchange has grown to be one of the tallest stock markets in Asia and its market capitalization has been increasing tremendously over the years. During these years, there has been a rapid growth and change in the securities market, more so in the secondary market. ‘Advanced technology and online based transactions have modernized the stock exchange. In terms of the number of companies listed and total market capitalization, the Indian equity market is large relative to the country’s stage of economic development.’23


With the Bharatiya Janata Party (BJP) winning the latest election and the government headed by Prime Minister Narendra Modi, there have been several changes in the policy pursued by the central government. Though it is too early to predict the forthcoming changes, it is possible that Modi’s government is likely to open up the economy further to incentivize foreign direct investment and do everything to rev up the Indian Capital Market, which at the fake end of Manmohan Singh government was dormant. There are already several positive indications towards the robust revival of the capital market.

Case 41.2 Major Indian Scams—A Case Study

Various deficiencies in the Indian capital market—misgovernance, greed, corruption, inefficiency and market manipulations—have resulted in a series of scams in the country. Some of the major scams that seriously dented investor’s confidence are listed below.

  1. 1. 1992—Harshad Mehta scam (market manipulation): This first stock market scam was one which involved both the bond and equity markets in India. The manipulation was based on the inefficiencies of the settlement systems in the Government of India (GoI) bond market transactions. A pricing bubble came about in equity market where the market index went up by 143 per cent between September 1991 and April 1992. The amount involved in the crisis was about INR 54 billion.
  2. 1993—MNC’s efforts at consolidation of ownerships: There were a number of reported cases in which several transactional companies were found to consolidate their ownership by issuing equity allotments to their respective controlling groups at steep discounts to their market price. In this preferential allotment scam at steep discounts to their market price. In this preferential allotment scam investors alone lost around INR 5,000 million.
  3. 1993–1994—Vanishing companies scam: Between July 1993 and September 1994, the stock market index zoomed by 120 per cent. During this boom 3911 companies that raised over INR 250,000 million vanished or did not set up projects as promised in their prospectus. This scam occurred because during the artificial boom, hundreds of obscure companies were allowed to make public issues at large share premia through high sales pitch of questionable investment banks and grossly misleading prospectus.
  4. 1994—M.S. Shoes’ affair (Insider trading): The dominant shareholder of M. S. Shoes East Ltd., Pawan Sachdeva, took large leverage positions through brokers at both the Delhi and Mumbai Stock exchanges to manipulate share prices prior to a rights issue. When the share prices crashed, the broker defaulted and BSE shut down for 3 days as a consequence. The amount involved in the default was about 170 million.
  5. 1995—Sesa Goa (price manipulation at BSE): This was caused by two brokers who later failed on their margin payments on leverage positions in the shares. The exposure was around INR 45 million.
  6. 1995—Rupangi Impex and Magan Industries Ltd. (price manipulations): The dominant shareholders implemented a short squeeze. In both the cases, dominant shareholders were found to be guilty of price manipulation. The amount involved was INR 5.8 million in the case of Magan Industries Ltd. And INR 11 million in the case of Rupangi Impex Limited.
  7. 1995—Bad delivery of physical certificates: When anonymous trading and nationwide settlement became the norm by the end of 1995, there was an increasing incidence of fraudulent shares being delivered into the market. It has been estimated that the expected cost of encountering fake certificates in equity settlement in India at the same time was as high as 1 per cent.
  8. 1995–1996—Plantation companies scam: This scam saw INR 500,000 million mopped by unscrupulous and fly-by-night operators from gullible investors who believed plantation schemes would yield huge returns.
  9. 1995–1998—Mutual fund scam: This scam saw public sector banks raising nearly INR 150,000 million by promising huge return, but all of them collapsed.
  10. 1997—CRB scam through market manipulation: C. R. Bhansali, a chartered accountant, created group of companies, called the CRB Group, which was a conglomerate of finance and non-finance companies. Market manipulation was an important focus of activities for this group. The non-finance companies routed funds to finance companies to manipulate prices. The finance companies would source funds from external sources using manipulated performance numbers. The CRB episode was particularly important in the way it exposed extreme failure of supervision on the part of RBI and SEBI. The amount involved in CRB scam was INR 7 billion.
  11. 1998—Market manipulation by Harshad Mehta: This was another market manipulation episode engineered by Harshad Mehta. He worked on manipulating the share prices of BPL, Videocon and Sterlite in collusion with their managements. The episode came to an end when the market crashed due to a major fall in index. Harshad Mehta did not have liquidity to maintain his leveraged position. In this episode, the top management of the BSE resorted to tampering with the records in the trading systems while trying to avert a payment crisis. The president, executive director and a vice-president of BSE had to resign due to this episode. This episode also highlighted the failure of supervision on part of the SEBI. The amount involved was of INR 0.77 billion.
  12. 1999–2000—The IT scam: During this 2-year period, millions of investors lost their entire investments, duped by firms that changed their names to sound infotech. But when the unsustainable dotcom bubble burst, the hapless investors realized that their stocks were not even worth the paper on which they were printed.
  13. 2001—Price manipulation by Khetan Parikh: This scam, known as the Ketan Parekh scam, was triggered off by a fall in the prices of IT stocks globally. Ketan Parekh was seen to be the leader of this episode, with leveraged positions on a set of stocks called the K-10 stocks. There were allegations of fraud in this crisis with respect to an illegal badla market at the Calcutta Stock Exchange and the banking scam.
  14. 2004—Dramatic slide in the stock market: Between 14 and 17 May, there was a dramatic fall in the scrips of Reliance, Hindustan Lever, State Bank of India, Infosys and ONGC. On 17 May, Sensex fell by 11.34 per cent. SEBI found that a dozen players, whose names were not divulged, were responsible for the rigging and had put them on notice. Earlier, the stock market crumbled on 14 May. On that day, on the Sensex, the largest loser was State Bank of India with a dip of 14.77 per cent. In all these falls, the market capital worth millions of rupees was wiped out, and consequently investors’ confidence was badly shaken.
  15. 2005—Demat scam: After a great deal of damage was done to retail investors, who lost opportunities to get their due allotment in several IPOs between 2003 and 2005, SEBI investigated 105 such cases and unearthed full details leading to the scam. It was found that certain entities had cornered shares reserved for retail investors by opening thousands of fictitious demat accounts, with active collusion of the depository participants in order to increase their changes of allotment. After allotment, these benami holders transferred these shares to their financiers, who in turn sold them soon after making sizeable profits. It was the small investors who lost out because of this unscrupulous practice. This has happened notwithstanding the rule that multiple applications are not allowed.
  16. 2009—Satyam’s accounting fraud: Ramalinga Raju, founder chairman of Satyam Computer Services, confessed in January 2009 that he has caused the company’s balance sheet of 2007–08 to be cooked. It had inflated figures for cash and bank balances of INR 50.40  billion, a non-existent accrued interest of INR 3.76 billion, an understated liability of INR 12.30  billion, an overstated debtors’ position of INR 4.90 billion. He claimed that neither he nor the managing director, Rama Raju, had benefited financially from the inflated revenues and that none of the board members had any knowledge of the situation in which the company was placed. Analysts opined that the Satyam’s is India’s own Enron scandal. Raju was arrested and charged with several offences, including criminal conspiracy, breach of trust and forgery. He resigned from Satyam after notifying the board and SEBI, and is currently in a Hyderabad prison along with his brother and former board member, Rama Raju, and the former CFO Vadamani Srinivas. It was alleged that Price water house Coopers, Satyam’s auditors had knowledge of the fraud perpetrated by Raju and helped him in the malpractice. The CID investigators told the court that the actual number of employees is only 40,000 and not 53,000 as claimed and Raju had been allegedly withdrawing INR 200 million every month for paying these 13,000 non-existent employees. The World Bank has banned Satyam its 8 year-long IT service provider due to inappropriate payments to Banks’ staff and for not maintaining documentation to support fees charged for its subcontractors. UK mobile payments company Unpaid Systems issuing Satyam for over USD 1 Billion on complaints of fraud, forgery and breach of contract. Full details are awaited pending complete investigation.

This series of scams has cast a shadow over the credibility of SEBI, and its capacity to create a safe and sound equity market.

Source: A.C. Fernando, Corporate Governance: Principles, Policies and Practices, New Delhi, India: Pearson Education, 2006.

Key Terms

Capital formation 590

Capital market 590

Listed companies 589

Market capitalization 589

Organized sector 595

Portfolio investment 599, 600

Primary market 591

Savings and investment 600

Secondary market 592

Securities market 589

Discussion Questions

41.1. Notwithstanding suitable legislations and SEBI’s regulations, the Indian capital market remains weak and inefficient. Why?

41.2. Do you think that the bourgeoning capital market in the wake of economic reforms can dispense with public financial institutions as a source of financing industries? Substantiate your answer with the help of recent experience.

41.3. Give a brief account of the ways in which savings have been mobilized for industrialization in India. Examine, in this context, the role of capital market and the hurdles that stand in the way of developing an efficient capital market.


1. Gordon, E. and Natarajan, K. (1999), Capital Market in India (Mumbai: Himalaya Publishing House).

2. Ibid.

3. Government of India (2007), Economic Survey 2007–2008 (Ministry of Finance, New Delhi: Government of India).

4. Ibid.

5. Ibid.

6. Fernando, A. C. (2009), ‘Capitalism Is Dead. Long Live Capitalism!’, Management Matters, 1(11) LIBA, Loyola College, Chennai: September 2008–February 2009.

7. HBL Bureau (2008), ‘Indian Stock Market Lost INR 2.30 lakh crore in September: Crisil’, The Hindu Business Line, 8 October.

8. ‘Foreign Exchange Reserves Fall by $7.9 billion’, The Hindu, 11 October.

9. ET Bureau (2009), ‘Markets Do a Poll Vault’, The Economic Times, 19 May.

10. Oommen A. Ninan (2009), ‘Sensex Creates History, Vaults 2111 Points’, The Hindu, 19 May.

11. Times News Network (2009), ‘Sensex Gives Manmohan a 21-ton Salute’, The Times of India, 19 May.

12. Tendulkar, S. (2009), Chairman of the Prime Minister’s Economic Advisory Council, Government of India, quoted in ‘Bull Run to Boost Cos Expansion Plans’, The Times of India, 19 May.

13. Times News Network (2009), ‘At 14%, Best Weekly Gain for Sensex in 17 years’, Times of India, 23 May.

14. ‘Investors Richer by INR 7 L cr in 7 Trading Session’, The Times of India, 27 May 2009.

15. Government of India (2008), Economic Survey 2007–08, Ministry of Finance, Government of India (New Delhi, India: Oxford University Press).

16. Insider trading implies trading in the scrip of a company by such a person who is closely associated with it and has access to unpublished price-sensitive information. Front running is indulged in by brokers. On being advised by institutions to execute bulk orders (buy or sell) that have the potential to push the market price (up or down), the brokers make deals in advance of institution orders and make profits for themselves.

17. Bajpai, G. N., ‘Corporate Governance and Development: Why It Matters?’,

18. Speech on ‘Corporate Governance and Development: Why it Matters’, Chairman, SEBI at the meeting at the Global Corporate Governance, Forum held on 04 November at Paris.

Suggested Readings

41.1. Government of India (1985), Report of the High Powered Committee on Stock Exchange Reform (New Delhi: Government of India).

41.2. Government of India (1991), Report of the High Powered Study Group on Established of New Stock Exchange (New Delhi: Government of India).

41.3 Gupta, L. C. (1991), Indian Shareowners (New Delhi, India: Society for Capital Market Research).

41.4. Gupta, S. B. (1988), Monetary Economics: Institutions, Theory and Practice (New Delhi).

41.5. Machiraju, H. R. (2009), The Working of Stock Exchanges in India (New Delhi: New Age International Publishers (P) Ltd).

41.6. Narasimham Committee, Government of India (1991), Report of the Committee on the Financial System (New Delhi: Government of India).

41.7. Patil, R. H. (1977), ‘Capital Markets—Many unfinished Tasks’, The Hindu, Survey of Indian Industry, 1977, p. 61.

41.8. Reserve Bank of India: Report on Currency and Finance (1998–99). Vol. I, Chapter 8.

41.9. Shah, A. and Thomas, S. (1997), ‘Securities Markets: Towards Greater Efficiency’ in Parikh, Kirit S. (ed), India Development Report (Delhi, India: Oxford University Press).

41.10. Shah, A. (1999), ‘Institutional Change in India’s Capital Market’, Economic and Political Weekly, 16–23 January 1999, pp. 183–194.