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Impact Of Globalization On The Indian Capital Markets Finance Essay

The purpose of this study is to examine the impact of the integration of worldwide capital markets on the economic growth and development of developing countries like India. Post liberalization the foreign capital inflows in the form of foreign portfolio investment (FPI) has improved liquidity conditions in the Indian capital markets. This in turn has channelized the savings of the populations to the high yield projects that were hitherto not taken up due to dearth of capital. With improved liquidity brought about by the capital inflows from abroad the retail investors can exit their position easily, making them keen to invest in equities, thus contributing to India’s economic development.

Introduction

The stock markets in the developing economies like India account for a significant share of the activities in the global markets. Lowering the barriers relating to the flow of international capital in the post liberalization period has enhanced the stock market liquidity (Levine, n.d.). Liquidity plays an important role in spurring the long term growth opportunities. In the absence of liquidity many profitable opportunities had to be foregone as people were unwilling to block their funds for long span of time. The increased liquidity in the Indian capital markets has been facilitated through foreign participation in the form of equity. Increased capital flows in the country have helped in improving the production base of the country. By way of this the total savings is distributed across countries with high potential that lack the necessary financial back-up. As a result of globalization the economic progress of a country is not affected by fund constraints. Studies have shown that an active capital market complemented by a sound banking system stimulate economic growth (BM&FBOVESPA, n.d.). The foreign participation in a country can take various forms like foreign institutional investment or foreign direct investment. In India the bulk of the foreign investment is in the form of foreign portfolio investment (Pal, 2006, pp.2).

For developing economies, foreign direct investment is the preferred expansion route. This is because there is no restriction on FII or portfolio investment. In the event of market uncertainty like political instability, the foreign investors are quick to withdraw their funds thus pulling down the markets. This was evident during the recessionary phase of 2008 when the foreign investors liquidated their long positions in the stock market in the fear of a collapse. In this context the FDI is the most reliant method of foreign capital, as it carries a minimum time frame before which an investor cannot withdraw his funds. This can be in various forms like equity joint venture, mergers and acquisitions, incorporating a subsidiary that is fully owned by the foreign holding company, acquisition of shares in an enterprise etc. FDI of nearly 100 percent is permitted under the automatic route for all the sectors barring a few where the government approval is mandatory (Department of Industrial Policy & Promotion, 2005). In this assignment the impact of the international capital participation in the economic progress of India has been discussed.

Research Question-

How has globalization boosted Indian economy?

Literature Review

The globalization originating towards the middle of the 1980’s has marked a significant increase in the capital flows to the developing countries (Prasad, 2003). William Ryan (1990) states that stock market serves as the provider of equity finance by mobilizing domestic savings, allocating capital for productive purposes as it links the capital market with the industrial world (Azarmi, 2005, pp. 64).

To ensure sustainable economic growth, funds needed must be channelized in a way as to enable the economy and the business to produce optimal output. The stock market of a country acts as an economic institution promoting efficient capital allocation and formation. The capital market assists the government and industry in raising funds for long term uses like funding new projects, expansion and modernization. A unique advantage offered by the stock market to the corporate entities is the accessibility of non debt and long term fund. By issuing equities the companies get an access to perpetual source of capital. The provision of equity mode of financing enables the companies to avoid an overdependence on debt. This besides improving the capital structure position of the business makes it financially flexible. As per Samuel et al, the existing literature refers to the fact that the growth and development in developed economies is fuelled by capital and money markets As per Nyong, the involvement of the capital market in the economic development is limited in the case of developing economies as they rely more on money market sources. According to Okereke-Onyiuke, equity funding is a cheap and flexible form of funding and is vital for an economy’s sustainable development. The growth in the stock market has added to the complexities arising from globalization. This has opened up the trading of a variety of financial instruments like equity options, currency options, currency futures, index futures and other types of derivatives. As per Alile, the aim of the worldwide stock markets remains the same which is maintenance of market efficiency that facilitates economic growth prospects. According to Samuel et al, there is a controversy among the analysts regarding the link between economic development and market performance which is based on their study of developing and developed economies. The financial composition of a firm’s capital structure is influenced by the growth in the economy as per Nyong (1997). Between equity and debt the tilt is in favour of equity issue through the stock markets.

The development of an economy raises the need of additional funding for meeting the expansionary programs. According to Alile (1984) the stock market acts as a “veritable tool” that facilitates the mobilization and distribution of the savings that are critical for the efficiency and growth of an economy. The overall growth of any economy largely depends on the efficiency with which the stock market performs its allocation function. The savings mobilized by the stock market is allocated on the basis of the firm’s prospect that is reflected from the rate of return and risk-level. As per Alile (1997) the capital resources are allocated based on the demand supply mechanism to the firms that promise high productivity, thus stimulating the economic growth and expansion.

On account of the benefits derived from the stock markets it remains central to the policy makers and economists. The stock market of a country is often referred to as the barometer of the business condition in a country. As per Obadan (1995) the stock market index of an active stock market can be used for measuring the changes in the level of economic activities.

Nyong (1997) states that the stock market is a complex institution entrusted with the task of mobilizing the funds of the major sectors such as household, government and firms and making them available to the other economic sectors. As per Inanga and Emenuga (1997) the development of the capital market plays a crucial role in the fund mobilization, resource allocation and information that is relevant for appraisal.

The boom in the emerging and developed stock markets is mainly dominated by the developing economies. This is mainly due to the reason that the firms can enjoy the advantage of lower equity cost when the stocks markets perform efficiently. Another reason is that the trading and hedging of securities reduces the risk. The markets make an adjustment in the stock prices thus controlling the investment behaviour of the business. Demirgüç-Kunt and Levine (1996) assume that the countries keen for foreign investment can obtain the same through stock exchange.

The services performed by the stock markets contribute to economic progress of a county directly as well as indirectly. Other than fund mobilization the other functions of stock market include creation of liquidity, risk management, improved dissemination of crucial information and incentives relating to better corporate control and regulation. The effectiveness with which the above functions are carried out can boost the rate of economic development and growth of the country.

Studies conducted have shown that countries with a developed financial system in the form of actively functioning stock markets and sound banking system exhibit faster growth rates (Deb & Mukherjee, 2008). At all the stages of development of an economy, the government as well as the private sector require long term financing sources. Like the companies need long term finance for setting up factories, acquisition of a new plant etc. Similarly the government requires funds for building infrastructure. The funding of such activities must be based on long-term sources of finance that is rendered by an efficiently operating stock market.

The foreign institutional investment has increased the liquidity in the stock markets of the growing economies. Buoyed by the high potential of these countries the FIIs spread their investment corpus across various countries. The liquidity in the capital market ensures that the retail investors park their funds in the equity instruments of the companies as they can easily liquidate their position. Till recently the investors were reluctant to invest their savings for long time periods. However the liquidity in the capital market brought about by the increased participation of the overseas investors provides the necessary capital for long term business growth. Bencivenga, Smith and Starr (1996) have asserted that in the absence of a liquid capital market it is not possible to attain industrial revolution. This is because the industrial projects are mainly long term based and have long gestation periods thereby making it unattractive to the savers who prefer to invest in investment vehicles of short term maturities.

The liquidity function is closely related by the risk diversification. The stock markets can fuel economic development if they are globally integrated. According to Obstfeld (1994) the projects with high returns are comparatively risky and therefore the stock markets that offer risk diversification can encourage taking up of high return projects. This boosts the economy and creates growth opportunities by transferring the money from domestic sources to the high yield projects.

An accelerated growth results in dissemination of important company information. An investor can profitably trade by monitoring the profit position of the firm. Improved information results in better resource allocation which in turn promotes economic development. As per Filler et al (1999) the significance of the link between stock market and economic development varies according to the level of development in the country with a greater impact on the countries that are less developed. Ed (1995) asserted that investment in securities is the mechanism of transforming the savings into economic prosperity of the nation. Osinubi (1998) states that, as per Harry Johnson, the prerequisite of being developed is to have a large capital stock per head, that is replenished and replaced every time it is used up. If this lacks the conditions of underdevelopment prevail (Osinubi, n.d.).

Research Plan

For the purpose of conducting the research proposal various primary and secondary sources can be used. The primary source will comprise setting of questionnaire and interviewing the respondents. The sample unit will comprise of the members of the Bombay Stock Exchange. Other than this the relevant data relating to other growth indicators in the economy like level of employment, improvement in gross output, derivative market, GDR, FCCB can be obtained from the secondary sources. Based on the response to the questions obtained from the members an interpretation of the research objective can be done.

Methodology & Data Collection

For carrying out an assessment of the set objective an empirical research based on the primary data collected through questionnaire and interview can be done. In the setting of the questions care must be taken to ensure that the questions are simple to interpret by the respondents. The questions must be presented in such a way as to avoid the influence of an answer by a previous reply. The questionnaire [1] comprises of the following questions-

For the members of Stock Exchange-

Has there been a significant increase in the number of clients?

Has there been an increase in the volume of daily trading?

Has there been an increase in the foreign alliances in the listed companies?

Has there been a rise in the number of listed companies?

Has the number of FPO’s moved up?

Data Collection-

In the primary method of data collection the most difficult part is interviewing the respondents. Moreover the data can be biased as the research is based on selected sample units. Here the sample unit comprises of the members of the Bombay Stock Exchange. As this exchange is the oldest exchange in the country it has been chosen for the purpose of research. A total of 100 respondents have been selected. But of the selected sample only 25 respondents answered all the questions. The findings of the research will be based on the mode of the answers that are provided by the respondents. Mode is a measure of central tendency that is based on the highest frequency of an outcome. Based on the mode of the answers given by the respondents an interpretation of the answers can be done.

The secondary sources of data like growth rate in derivative market, economic growth of GDP, rate of unemployment, per capita income, foreign direct investment and exchange rate for assessing objectives can be obtained from various online sources like journal articles, websites of the various government departments, stock exchange etc.

The growth rate in GDP is an important indicator of the impact of the strengthened capital markets and stable financial system. The GDP growth rate of the country has increased from the lows to the extent that the country ranks among the fastest growing nations in the world.

The capital inflow has reduced the overdependence on agriculture as more people are being absorbed in the service sector. The details pertaining to the growth rate in the service sector post 1991 is available from the secondary data compiled by New Delhi Embassy (Embassy New Delhi, n.d.).

The volume of trading on the Indian bourses has increased after the foreign capital started pouring in after liberalization. Since 1991 there has been a rapid growth in the primary market after the removal of restrictions relating to foreign capital investment. The data relating to the growth of the primary market is available from the online sources.

Besides this there has been a remarkable increase in the Foreign Currency Convertible Bonds (FCCB) and Global Depository Receipts (GDR) that enable the company to issue capital from the overseas markets (Cho, n.d.).

The derivative market in the country has shown a remarkable growth after the integration of the Indian capital markets with their global counterpart. This has facilitated the corporate to hedge their overseas exposure by taking the necessary position. As the value of their receivables and payables remain intact they can enter into more overseas transactions. This has made the country an important outsourcing destination. Besides creating job opportunities it has helped in the infrastructural development of the country.

Reference

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BM&FBOVESPA. No date. The capital market as an instrument for the economic development. Available at: http://www.bmfbovespa.com.br/Pdf/bovespanews_25102002.pdf

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Cho, J.Y. No date. Indian Capital Market Recent Developments and Policy Issues. Available at:

http://www.adb.org/Documents/Books/Rising_to_the_Challenge/India/india

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Deb, G.S. Mukherjee, J. 2008. Does Stock Market Development Cause Economic Growth? A

Time Series Analysis for Indian Economy. International Research Journal of Finance and Economics. Available at: http://www.eurojournals.com/irjfe_21_12.pdf

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Department of Industrial Policy & Promotion. 2005. Foreign Direct Investment-Policy

& Procedures. Available at: http://dipp.nic.in/manual/manual_03_05.pdf

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Levine, R. No Date. Stock Markets , Economic Development, and Capital Control

Liberalization. Available at: http://www.ici.org/pdf/per03-05.pdf

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Osinubi, S.T. No Date. Does Stock Market Promote Economic Growth In Nigeria?. Available at:

http://sta.uwi.edu/conferences/financeconference/Conference%20Papers/Session%202/Does%20the%20Stock%20Market%20promote%20Economic%20Growth%20in%20Nigeria.pdf

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Pal, P. 2006. Foreign Portfolio Investment, Stock Market and Economic Development: A Case Study of India. Available at:

http://www.policyinnovations.org/ideas/policy_library/data/01408/_res/id=sa_File1/Partha_ACDC_Paper.pdf

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Prasad, S.E. Rogoff, K. Wei, S. KOse, A.M. 2003. Effects of Financial Globalization on Developing Countries. IMF. Available at:

http://www.imf.org/external/pubs/nft/op/220/index.htm

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