Recent trends in Indian & global capital markets.
Dr. Piyush prakash (Reader: D.A.V. College Kanpur)
and Sandhya Dubey
Overview of Indian Capital Market
The Indian capital market is more than a century old. Its history goes back to 1875, when 22 brokers formed the Bombay Stock Exchange (BSE). Over the period, the Indian securities market has evolved continuously to become one o the most dynamic, modern, and efficient securities markets in Asia. Today,
Indian market confirms to best international practices and standards both in terms of structure and in terms of operating efficiency .Indian securities markets are mainly governed by a) The Company’s Act1956, b) the Securities Contracts (Regulation) Act 1956 (SCRA Act), and c) the Securities and Exchange Board of India (SEBI) Act, 1992. A brief background of these above regulations are given below
a) The Companies Act 1956 deals with issue, allotment and transfer of securities and various aspects relating to company management. It provides norms for disclosures in the public issues, regulations for underwriting, and the issues pertaining to use of premium and discount on various issues.
b) SCRA provides regulations for direct and indirect control of stock exchanges with an aim to prevent undesirable transactions in securities. It provides regulatory jurisdiction to Central Government over stock exchanges, contracts in securities and listing of securities on stock exchanges.
c) The SEBI Act empowers SEBI to protect the interest of investors in the securities market, to promote the development of securities market and to regulate the security market.
The Indian securities market consists of primary (new issues) as well as secondary (stock) market in both equity and debt. The primary market provides the channel for sale of new securities, while the secondary market deals in trading of securities previously issued. The issuers of securities issue (create and sell) new securities in the primary market to raise funds for investment. They do so either through public issues or private placement. There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity instruments (shares, debentures, etc.), while the governments (central and state governments) issue debt securities (dated securities, treasury bills). The secondary market enables participants who hold securities to adjust their holdings in response to changes in their assessment of risk and return. A variant of secondary market is the forward market, where securities are traded for future delivery and payment in the form of futures and options. The futures and options can be on individual stocks or basket of stocks like index. Two exchanges, namely National Stock Exchange (NSE) and the Stock Exchange, Mumbai (BSE) provide trading of derivatives in single stock futures, index futures, single stock options and index options. Derivatives trading commenced in India in June 2000
Other leading cities in stock market operations
Ahmedabad gained importance next to Bombay with respect to cotton textile industry. After 1880, many mills originated from Ahmedabad and rapidly forged ahead. As new mills were floated, the need for a Stock Exchange at Ahmedabad was realized and in 1894 the brokers formed “The Ahmedabad Share and Stock Brokers’ Association”.
What the cotton textile industry was to Bombay and Ahmedabad, the jute industry was to Calcutta. Also tea and coal industries were the other major industrial groups in Calcutta. After the Share Mania in 1861-65, in the 1870’s there was a sharp boom in jute shares, which was followed by a boom in tea shares in the 1880’s and 1890’s; and a coal boom between 1904 and 1908. On June 1908, some leading brokers formed “The Calcutta Stock Exchange Association”.
In the beginning of the twentieth century, the industrial revolution was on the way in India with the Swadeshi Movement; and with the inauguration of the Tata Iron and Steel Company Limited in 1907, an important stage in industrial advancement under Indian enterprise was reached.
Indian cotton and jute textiles, steel, sugar, paper and flour mills and all companies generally enjoyed phenomenal prosperity, due to the First World War.
In 1920, the then demure city of Madras had the maiden thrill of a stock exchange functioning in its midst, under the name and style of “The Madras Stock Exchange” with 100 members. However, when boom faded, the number of members stood reduced from 100 to 3, by 1923, and so it went out of existence.
In 1935, the stock market activity improved, especially in South India where there was a rapid increase in the number of textile mills and many plantation companies were floated. In 1937, a stock exchange was once again organized in Madras – Madras Stock Exchange Association (Pvt) Limited. (In 1957 the name was changed to Madras Stock Exchange Limited).
Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with the Punjab Stock Exchange Limited, which was incorporated in 1936.
Indian Stock Exchanges – An Umbrella Growth
The Second World War broke out in 1939. It gave a sharp boom which was followed by a slump. But, in 1943, the situation changed radically, when India was fully mobilized as a supply base.
On account of the restrictive controls on cotton, bullion, seeds and other commodities, those dealing in them found in the stock market as the only outlet for their activities. They were anxious to join the trade and their number was swelled by numerous others. Many new associations were constituted for the purpose and Stock Exchanges in all parts of the country were floated.
The Uttar Pradesh Stock Exchange Limited (1940), Nagpur Stock Exchange Limited (1940) and Hyderabad Stock Exchange Limited (1944) were incorporated.
In Delhi two stock exchanges – Delhi Stock and Share Brokers’ Association Limited and the Delhi Stocks and Shares Exchange Limited – were floated and later in June 1947, amalgamated into the Delhi Stock Exchange Association Limited.
There are two major indicators of Indian capital market- SENSEX & NIFTY:
What are the Sensex & the Nifty?
The Sensex is an “index”. What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down. The Sensex is an indicator of all the major companies of the BSE. The Nifty is an indicator of all the major companies of the NSE. If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down. Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE. Just in case you are confused, the BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE. Most of the stock trading in the country is done though the BSE & the NSE . Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of index.Unless stock markets provide professionalized service, small investors and foreign investors will not be interested in capital market operations. And capital market being one of the major source of long-term finance for industrial projects, India cannot afford to damage the capital market path. In this regard NSE gains vital importance in the Indian capital market but if we see the sensex & nifty graph there is a great variation.
Down fall or variability in returns. To measure all these crisis FM (Finance minister) of India has done some measures which are following :
FM says state-run banks ready to provide credit to small, medium business sectors
RBI to keep a close watch on liquidity
Finance Minister P Chidambaram today said the Reserve Bank of India (RBI) will keep a close watch on liquidity and state-run banks are ready to provide credit to the small and medium business sectors. The finance minister today met the chiefs of state-run banks.
Exports growth slumps to 10.4% in September 2008
Exports up by 30.9% in April-September 2008
Indian merchandise exports during September 2008, recorded meager 10.4% growth at US $ 13.75 billion, taking the toll from recessionary tendencies in major export destination in US and Europe. On the other hand import growth remaining buoyant surged 43.34% to US $ 24.38 billion, causing the trade deficit to more than double to US $ 10.63 billion in September 2008 compared to US $ 4.55 billion in September 2007. Global financial crisis and recessionary tendencies in major economies have severely impacted India’s export growth, though import surged rampantly.
Soaring crude oil prices placed immense pressure on import bill during the month of September 2008. The share of oil import in total imports surged to 37.31% in September 2008 compared to 34.05% in the corresponding period last year. Oil imports during September 2008 surged 57.1% to US $ 9.1 billion, whereas non-oil import increased 36.2% to US $ 15.28 billion. Cumulative oil import during April-September 2008 stood 59.2% higher at US $ 55.06 billion, while non-oil imports surged 29.3% to US$ 99.68 billion over corresponding period last year.
Exports during April- September 2008 expanded 30.90% to US $ 94.97 billion (36.7% to Rs.405118 crore) while imports advanced 38.6% to US $ 154.74 billion (44.9% to Rs 661208 crore).
In rupee terms, exports scaled up 24.7% to Rs.62641 crore, while imports increased by 61.9% to Rs 111085 crore, in September 2008 compared corresponding period last year.
Trade deficit in April-September was estimated at $59.77 billion as against $39.1 billion in the same period the last fiscal.
PM says govt will take all steps to protect growth
Govt working closely with other countries for coordinated policy action
Prime Minister Manmohan Singh told top business leaders on Monday, 3 November 2008, that the government will take all the necessary monetary and fiscal policy measures to protect growth. The Prime Minister also said the government was working closely with other countries to ensure coordinated policy action for the containment of the global financial crisis.
RBI slashes CRR and SLR by 100 bps each and Repo rate by 50 bps
CRR revised to 5.5%, Repo rates to 7.5% while SLR stands reduced to 24%
RBI has cut CRR by 100 basis points to 5.5%, SLR by100 basis points to 24% and repo rate by 50 basis points to 7.5%, in a surprise move on 1st November 2008. Though the market was expecting a cut, the market is surprised by strong dose of cut in all the three rates in one go.
The cut in CRR will be implemented in two phases of 50 basis points each. CRR will come down to 6.0% effective from the fortnight beginning 25th October 2008 and further down to 5.5% effective from the fortnight beginning 8th November 2008. Incidentally, this is in addition to 250 basis points cut in CRR effective from the fortnight beginning 11th October 2008. Thus, in October 2008 alone, we are seeing 300 bps cut and another 50 bps cut in November 2008. The latest 100 basis point cut in CRR will bring in Rs 40000 crore into the banking system. Together, the 350 basis points cut across October and November 2008 will bring in Rs 140000 crore into the banking system
Since 16 September RBI has been offering an additional liquidity support for banks to the extent of 1% of NDTL under the Liquidity Adjustment Facility (LAF) along with waiver of penal interest. Now, RBI making this reduction permanent has reduced the Statutory Liquidity Ratio (SLR) by 100 bps to 24% of NDTL effective from the fortnight beginning 8th November 2008.
RBI has also introduced a special refinance facility for all scheduled commercial banks (excluding RRBs) to provide refinance up to 1% of the relevant bank’s NDTL as of 24th October 2008 at the LAF repo rate up to a maximum period of 90 days. RBI said that during this period, refinance could be flexibly drawn and repaid.
In addition to the cut in SLR and special refinance facility, RBI also extended the limit of liquidity support for banks from 0.5% to 1.5% of NDTL under LAF through relaxation in the maintenance of SLR and the coverage is extended to NBFCs also. Further, RBI said that banks can apportion the total accommodation allowed between Mutual funds and NBFCs flexibly as per their business needs. But RBI directed that this relaxation in SLR should be exclusively used for the purpose of meeting the funding requirement of NBFCs and Mutual funds.
RBI has asked the entities with bulk forex requirements to approach it through their banks. Accordingly, RBI will sell foreign exchange through agent banks to augment supply in the domestic foreign exchange market or intervene directly to meet any demand supply gaps.
RBI has also allowed non-deposit taking NBFCs (NBFCs-ND-SI), as a temporary measure, to raise short-term foreign currency borrowings under the approval route. However, this will be subject to their compliance with prudential norms on capital adequacy and exposure norms.
Further, in the context of forex outflows in the recent period, RBI has decided to conduct buy back of MSS dated securities so as to provide another avenue for injecting liquidity of a more durable nature into the banking system. RBI indicated that this would be calibrated with the market-borrowing programme of the Government of India.
On the growth front, it is important to ensure that credit requirements for productive purposes are adequately met so as to support the growth momentum of the economy. However, the global financial turmoil has had knock-on effects on our financial markets; this has reinforced the importance of focusing on preserving financial stability. The Reserve Bank has reviewed the current and evolving macroeconomic situation and liquidity conditions in the global and domestic financial markets. Based on this review, RBI has taken slew of above measures, including cut in CRR, SLR and repo rate. The total liquidity support provided through the latest reductions in the CRR, SLR and temporary accommodation under the SLR is likely to be in the order of Rs.1,40,481 crore. With RBI announcing slew of liquidity boosting measures overall interest regime in the country is likely to ease in the near term. Some of the banks have already announced interest rate reduction and more are likely to follow soon. The reduction in SLR would release much needed liquidity into the system and signals reduction in the interest rates.
The Reserve Bank will continue to closely monitor the developments in the global and domestic financial markets and will take swift and effective action as appropriate.
Rate cuts at corner
In the wake of the stress on our financial markets as a result of the global financial crisis, the Reserve Bank announced a series of measures starting mid-September 2008 to ease both domestic and foreign exchange liquidity. The task of monetary policy has always centered on managing a judicious balance between price stability, sustaining the growth momentum and maintaining financial stability. The relative emphasis across these objectives has varied from time to time depending on the underlying macroeconomic conditions. At this juncture, the apex bank of the country has focused on financial stability thanks to ease in inflation.
India witnesses the effects global meltdown through liquidity crunch, which reflected in significant growth in call rates- the rate at which banks borrows from each other. The month started with 16.51% weighted call rates which further moved up to18.53% as on 10 October 2008. On review of the liquidity situation, the RBI announced a reduction in CRR by 250 bps to 6.5% effective from fortnight beginning on 11 October 2008. As result of reduction of the reduction in the CRR around Rs 1,00,000 crore was expected to be released into the banking system. The RBI also decided to open a special 14-day fixed rate repo window for a notified amount of Rs 20000 crore with a view to enabling banks to meet the liquidity requirement of mutual funds.
Reflecting the impact of these measures, the average call rate declined to 9.92% as on 13 October 2008 and further tanked to 6.6% as on 17 October and slipped below reverse repo rate to 4.16% on 18 October 2008. However we have seen pressure mounting on inter bank call money rates since 25 October, as banks scrambled to borrow at call money market to meet funding requirements in a holiday-shortened week, while fresh debt auctions also weighed. The RBI has conducted the auctions of Rs 7000 crore worth of treasury bills on 29 October, while Rs 10000 crore worth of securities will be auctioned on 31 October. As result call rates surged to 8.56% on 25 October and further up to 9.35% and 11.26%, as on 27 and 29 October 2008, respectively. The RBI is committed to maintain close watch on the entire financial system to prevent pressures building up in the financial markets and it may take appropriate steps if pressures persist.
The sharp dip in the crude oil prices, RBI aims liquidity boosting measures and easing inflation has compounded bullish sentiments in the bonds market, raising the bond prices incessantly. The yield on 10- year benchmark government securities (g-sec 8.24% 22 April 2018) eased substantially to its 8 months low level 7.5% on 29 October 2008 from 8.44% on 1 October 2008. Bond yield and inflation has a positive co-relation, whereas bonds trade transmits an inverse price-yield relationship. During the week ended 18 October 2008, general price index popularly called inflation has down to 10.68%. It was the fifth sequential week were the inflation has declined on week on week basis. The downtrend in inflation will give leverage to the apex bank of the country to act aggressively on financial stability with further cut in interest rates.
Along with inflation, we have seen slight deceleration in money supply growth. According to the latest data released by RBI, the annual growth rate in broad money or M3 has below 20% mark. However it is still above the comfort zone of the apex bank (RBI holding 17% target for the current financial year).
Central banks across the globe are trying to curb an economic slowdown as the financial crisis weighs on consumer sentiment and business spending. The Federal Reserve’s reduced interest rates by 50 bps to 1% on 29 October in order to stimulate economic growth by encouraging consumer and business spending. In Asia, China’s central bank announced itâ€™s third reduction by 27 basis points to 6.93%, while Taiwan’s central bank surprised with a 25 bps cut in lending rates to 3%, its fourth easing in two and a half months. Similarly the market expects rate cut to be announced in Japan on Friday, while European Central Bank and Britain may add to monetary easing in the ensuing weak to restrict the adverse impact of what could be the worst financial crisis in 80 years and its impact in terms of a long global recession. Against the backdrop of these global and domestic developments and in the light of measures taken by the Reserve Bank over the last month, we are excepting further dose of medicine from the apex bank of the country.
RBI prefers to buy time and leaves all rates unchanged
But cuts GDP growth projections to 7.5 to 8.0% for FY 2008-09
RBI has declared mid-term policy review with stable interest rates. Effective from the fortnight beginning 11th October 2008, the CRR was already cut by 250 basis points to 6.5% while repo rate was cut by 100 bps effective form20th October 2008. But still select Industry associations were expecting further cut in repo / CRR. Instead, RBI has decided to wait and watch, before taking further monetary measures.
However the Reserve Bank has revised the projection of overall real GDP growth for 2008-09 to a range of 7.5-8.0 per cent, down from its own projection of around 8.0% in July 2008, thanks to global and domestic development.
1)The Bank Rate has been kept unchanged at 6.0 per cent.
2)The repo rate under the LAF has been kept unchanged at 8.0 per cent.
3)The reverse repo rate under the LAF has been kept unchanged at 6.0 per cent.
4)The cash reserve ratio (CRR) of scheduled banks is currently at 6.5 per cent of net demand and time liabilities (NDTL). On a review of the current liquidity situation, it has been decided to keep the CRR unchanged at 6.5 per cent of NDTL.
The market reaction on the policy was negative as market participants had expected further rate cut. However there is no change in any rate of interest as well as in CRR and SLR.
The apex bank of the country has already taken slew of measures in response to the developments in the global and domestic market in the last few weeks. Hence, RBI has preferred to observe the impact of these measures rather than rushing with additional dose of medicine.
Meanwhile, for four consecutive weeks, inflation rate has been coming down on week on week basis. Nevertheless, RBI has unchanged the inflation target for the remaining year, evidencing its discomfort on the underlying pressure on price level. At the same time we have not seen any change in target for money supply. With the reference of the recent date published by RBI, the growth in money supply was slightly down, but still far away from the target of the RBI (17%).
The recent measures taken by the apex bank (CRR and Repo cut) will boost the liquidity in the market along with the relaxation in ECB norms will play critical role in overall monetary assessments for the remaining financial year.
To sum up, the unchanged interest rate , and the downward revision in GDP growth target together indicate that apex bank has tried to maintain the balance between growth and inflation. However this is one of the most critical challenge for policy makers worldwide to make a choice between stable inflation or growth. At home ground, RBI preferred to buy the time to see the impact of the measures that has already placed.
No change in the policy rates or CRR in the Mid Term Review
RBI’s Mid Term Review of Annual Policy keeps all rates unchanged
Dr D Subbarao, Governor, Reserve Bank of India, unveiled the Mid Term Review of Annual Policy for the Year 2008-09 on 24th October 2008.
RBI has kept the Bank Rate, Repo Rate, Reverse Repo Rate and Cash Reserve Ratio unchanged. In effect, no major monetary measures have been taken in the Mid Term review on 24th October 2008.
RBI has revised India’s GDP growth projection for FY 2008-09 to a range of 7.5 to 8.0% on 24th October 2008, down from its own earlier projection of around 8.0% in July 2008.
RBI cuts India’s GDP growth projection to 7.5 to 8.0% for FY 2008-09
GDP growth projection cut from 8.0% made in July 2008
RBI has revised India’s GDP growth projection for FY 2008-09 to a range of 7.5 to 8.0% on 24th October 2008, down from its own earlier projection of around 8.0% in July 2008.
Dr D Subbarao, Governor, Reserve Bank of India, unveiled the Mid Term Review of Annual Policy for the Year 2008-09 on 24th October 2008. The downward revision in GDP projections were made in this review.
RBI indicated that in its First Quarter Review in July 2008, it had projected India’s projection of real GDP growth in 2008-09 at around 8.0 per cent for policy purposes. But RBI said that since then, there have been significant global and domestic developments which have rendered the outlook uncertain, and have increased the downside risks associated with this projection.
In particular, RBI highlighted that the global downturn may be deeper and more protracted than expected earlier. Consequently, the adverse implications through trade and financial channels for emerging economies, including India, have amplified.
RBI cautioned that if the recession is deeper and the recovery is long drawn as is the current expectation, emerging economies have also to contend with second round effects in the form of potential terms of trade losses, erosion of export competitiveness and restricted external financing. These adverse developments are overlaid on the moderation of growth in the industrial and services sectors in the first half of 2008-09.
RBI also said that the south-west monsoon conditions and water storage levels support the prospects of maintaining the medium-term trend growth rate in agriculture in 2008-09.
Taking these developments and prospects into account, the Reserve Bank has revised the projection of overall real GDP growth for 2008-09 to a range of 7.5-8.0 per cent
Foreign Institutional Investment in India
The liberalization and consequent reform measures have drawn the attention of foreign investors leading to a rise in portfolio investment in the Indian capital market. Over the recent years, India has emerged as a major
recipient of portfolio investment among the emerging market economies. Apart from such large inflows, reflecting the confidence of cross-border investors on the prospects of Indian securities market, except for one year, India received positive portfolio inflows in each year. The stability of portfolio flows towards India is in contrast with large volatility of portfolio flows in most emerging market economies.
The Indian capital market was opened up for foreign institutional investors (FIIs) in 1992. The FIIs started investing in Indian markets in January1993. The Indian corporate sector has been allowed to tap international capital markets through American Depository Receipts (ADRs), Global Depository
Receipts (GDRs), Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings (ECBs).Similarly, non-resident Indians (NRIs) have been allowed to invest in Indian companies. FIIs have been permitted in all types of securities including Government securities and they enjoy full capital
convertibility. Mutual funds have been allowed to open offshore funds to investing equities abroad. FII investment in India started in 1993, as FIIs were allowed to invest in the Indian debt and equity market in line with the recommendations of the High-Level Committee on Balance of Payments. These investment inflows have since then been positive, with the exception of 1998-99, when capital flows to emerging market economies were affected by contagion from the East Asian crisis. These investments account for over 10 per cent of the total market capitalization of the Indian stock market.
Limits on Foreign Institutional Investors
Each FII (investing on its own) or sub-account cannot hold more than 10 per cent of the paid-up capital of a company. A sub-account under the foreign corporate/individual category cannot hold more than 5 per cent of
the paid up capital of the company. The maximum permissible investment in the shares of a company, jointly
by all FIIs together is 24 per cent of the paid-up capital of that company. The limit is 20 per cent of the paid-up capital in the case of public sector banks. The ceiling of 24 per cent for FII investment can be raised up to
sectoral cap/statutory ceiling, subject to the approval of the board and the general body of the company passing a special resolution to that effect. A cap of US $1.75 billion is applicable to FII investment in dated
Government securities and treasury bills under 100 per cent and the 70:30route. Within this ceiling of US $1.75 billion, a sub-ceiling of US $200 million is applicable for the 70:30 route. (FIIs are required to allocate their
investment between equity and debt instruments in the ratio of 70:30.However, it is also possible for an FII to declare itself a 100 per cent debt FII in which case it can make its entire investment in debt instruments.)
A cumulative sub-ceiling of US $500 million outstanding has been fixed on FII investments in corporate debt and this is over and above the sub- ceiling of US $1.75 billion for Government debt.
Recent trends in the global capital markets :
Several current trends will continue to influence the world’s financial markets long after the present bout of turbulence ends.
FEBRUARY 2008 • Diana Farrell, Christian S. Fölster, and Susan Lund
Struggling credit markets, slumping stocks, and a sliding dollar have been generating anxiety among executives and policy makers in early 2008. Amid the turmoil, it’s easy to forget that long-term structural change in the world’s capital markets will probably prove more important than short-term fluctuations, as it did after the 1987 US stock market crash, the 1992 assault on the British pound, and the 1997 unraveling of Asia’s financial markets.
Recent McKinsey Global Institute (MGI) research highlights several trends that look set to continue during the years ahead, long after the present bout of market turbulence has ended:
the continued growth and deepening of global capital markets as investors pour more money into equities, debt securities, bank deposits, and other assets around the world
the soaring growth of financial markets in emerging economies and the growing ties between financial markets in developed and developing countries
the shift of financial weight in Asia from Japan toward China and other fast-growing emerging markets
the growing financial clout of the eurozone countries and the significance of the euro
the burgeoning role of oil-rich Middle Eastern countries as suppliers of capital to the world, along with the rise of new financial hubs in the Middle East to complement the rapidly growing hubs in London and Asia
While these trends reflect a shift in financial power from the United States toward other parts of the world, the sheer size and depth of the US market will give it a leading role on the international financial stage for years to come.1
The exhibits that follow track the progress of these long-term shifts. The research rests on several proprietary MGI databases that cover the financial assets, cross-border capital flows, and foreign investments of more than 100 countries since 1990. Most of the analysis focuses on developments through 2006, the most recent year for which comprehensive data are available. But some data also show that many of the broad trends continued through late 2007 and will probably persist in years to come.
The continued growth of global financial assets
The full fallout from the credit market volatility of 2007 remains to be seen. But over the longer term, the volume of global financial assets (the value of all bank deposits, government debt securities, corporate debt securities, and equity securities) will continue to expand. Over the past 25 years, through stable and stormy times alike, financial assets have grown robustly. In 2006, their value rose to $167 trillion, from $142 trillion the year before—a 17 percent increase, more than double the average annual growth rate (8 percent) from 1995 through 2005.2
For many years, as equity and bond markets thrived, bank deposits have accounted for a shrinking share of total financial assets. That trend continued in 2006, but the rate of decline slowed because the absolute value of bank deposits around the world jumped by $5.6 trillion—twice the average increase of the previous three years.3 The largest contributor to this rise was the United States, thanks largely to strong income growth and the housing boom, which enabled many households to tap their home equity for quick cash. This source of growth was shaky by 2007. Looking forward, the growth of deposits will depend to a large degree on China, where they are the primary savings vehicle.
Growing cross-border investment links financial markets
The rising level of foreign investment is making the world more financially inter-dependent than it was even a few years ago. By the end of 2006, the outstanding stock of cross-border investments reached the highest level, in real terms, in history—$74.5 trillion of assets. This sum includes the foreign investments of multinational corporations, purchases of foreign debt and equity securities by investors around the world, and foreign lending and deposits. Preliminary data indicate that the total grew to another record level in 2007, despite the disruptions in European and US credit markets during the second half of the year.
What’s more, the source and direction of cross-border investment flows are shifting. In 1999, the United States was the dominant hub of the global financial system. By 2006, it remained the largest single foreign investor and a major hub in global capital markets—but the eurozone countries together had as many financial links with other parts of the world, including emerging markets. The United Kingdom too has become a more significant global financial hub, and Middle Eastern countries are now major investors in global financial markets, thanks to the windfall generated by rising oil prices. In 2006, for the first time since the 1970s, the oil-exporting countries joined those of East Asia as the world’s largest net suppliers of capital.
The Indian financial system has undergone structural transformation over the past decade. The financial sector has acquired strength, efficiency and stability by the combined effect of competition, regulatory measures, and policy environment. While competition, consolidation and convergence have been recognized as the key drivers of the banking sector in the coming years, consolidation of the domestic banking system in both public and private sectors is being combined with gradual enhancement of the presence of foreign banks in a calibrated manner. There has been improvement in banks’ capital position and asset quality as reflected in the overall increase in their capital adequacy ratio and declining NPLs, respectively. Significant improvement in various parameters of efficiency, especially intermediation costs, suggests that competition in the banking industry has intensified. The efficiency of various segments of the financial system also increased. The major challenges facing the banking sector are the judicious deployment of funds and the management of revenues and costs. Concurrently, the issues of corporate governance and appropriate disclosures for enhancing market discipline have received increased attention for ensuring transparency and greater accountability. Financial sector supervision is increasingly becoming risk based with the emphasis on quality of risk management and adequacy of risk containment. Consolidation, competition and risk management are no doubt critical to the future of Indian banking, but governance and financial inclusion have also emerged as the key issues for the Indian financial system. The capital market in India has become efficient and modern over the years. It has also become much safer. However, some of the issues would need to be addressed. Corporate governance needs to be strengthened. Retail investors continue to remain away from the market. The private corporate debt market continues to lag behind the equity segment.