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24 August 2017, Gateway House

India’s capital markets at 70

India’s equity markets are a success story in the country’s 70th year of independence, and there are two prominent state institutions responsible for this, the Securities and Exchange Board of India and the National Stock Exchange. SEBI has played an extraordinary role in bringing in market efficiency, but as the equity market regulator, it must have the corporate surveillance function as well

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Indian companies are poised to raise a record sum through primary equity issuance in 2017. There are expectations that, by the end of the financial year in March 2018, around Rs. 500-600 billion will have been raised through the primary equity market[1] – more than the Rs. 515 billion raised a decade ago in 2007-08.[2] This is good.

Capital markets are about intermediating capital between savers and users and not just limited to efficient secondary exchange of shares between individuals and institutions. India’s equity markets are, for the most part, a success story. The debt market is underdeveloped and the record of the banking industry is patchy, at best.

At 70, India’s equity market is the jewel in its financial market crown. It is important to review its success ingredients and preview the task ahead for the next five years, if not 30. As the Indian economy grows in size, Indian markets will become more integrated with the rest of the world. Indian companies will tap into global markets for funding and global corporations too will, over time, tap into Indian savings. India’s capital market – and its regulator – must be prepared in advance for these developments and, in the process, become a model regulator for other developing nations.

Retelling a success story

Rakesh Mohan, former Deputy Governor of the Reserve Bank of India (RBI) attributes the success of India’s equity market to two major state institutions: the Securities and Exchange Board of India (SEBI) and the National Stock Exchange (NSE). Securities market regulator, SEBI, was established in 1988[3], and the NSE in 1992 as the first demutualised electronic exchange in India: in the last 25 years, the Indian stock market has been transformed.

At first, all that India had was the Bombay Stock Exchange (BSE). Established in 1875, it was Asia’s first stock exchange and ran under archaic trading and settlement systems. Indeed, till the mid-1990s, India’s long stock market history was its disadvantage. It was the world’s greatest and longest paper chase to execute trades and settle stock market transactions. The BSE too is now modernised, and, together with the NSE, the two are in the top five markets of the world in terms of trading volumes.[4]

Besides SEBI, the stock market regulator, and NSE, the establishment of the National Securities Depository Limited (NSDL) in 1996 was an important milestone. This pushed paperless trading – or dematerialisation (‘demat’) – which enabled high volumes in trading, eliminated clearing and settlement risk, and ensured good delivery. It was a timely measure too as stock market crimes on duplicate stock ownership certificates had begun occurring and could have taken on alarming proportions. Terrorism appeared in the early 1990s as a global curse. A paper-based market would have been vulnerable to considerable and sustained economic attack.

The setting up of NSDL is a fine case study for not the world alone, but for India too. The government restricted itself to being the legislator. It passed the Depository Act. But it did not sit at the table in the implementation. That was the preserve of the stock exchanges, NSDL, and the market as a whole. SEBI oversaw the entire programme and ensured coordination.

The goal of demat trading was achieved in a strategic way, with an implementation focus on ensuring early success – or the firing of bullets before cannonballs. NSDL started with eight stocks that were important for institutional investors. These were the most traded and they constituted around 80% of the trading volumes. All other stocks were gradually converted to the paperless format. In five years, over 95% of the ‘free float’ was in demat form.

Shielding small investors’ interests

As the stock market became more transparent and efficient and open to foreign institutional investors (FII), domestic promoters too began to see their own role in a different light. Stock prices started to reflect faith in the ‘owner/manager’ by a differential Price-Earnings (PE) ratio: higher integrity attracted higher PE and lower integrity was cursed with lower PE. The Indian promoter saw that a rupee stolen from the company was merely a rupee in his pocket, but a rupee left behind in the company was wealth (in terms of market capitalisation) which was 10 or 20 times the company’s earnings. This singularly changed promoter attitude to minority shareholders.

The regulator’s mission of protecting the small investor was also evident in the aftermath of the crisis of 2008 when many advanced nations banned short-selling. India did not ban short sales, which made it one of the only three markets in the world, along with Hong Kong and Singapore, that did not ban short sales. This proved effective in managing volatility in the markets. Information flow is critical to market efficiency and functioning. Banning short-selling is banning information that is critical to two-way bets in the market. It is not the same as banning speculation since speculation on the long side is encouraged in many ways, including by cutting interest rates to zero and flooding the economy and markets with liquidity (Quantitative Easing): this was the response of the advanced nations, who preached one thing and practised another.

Tasks ahead in SEBI’s evolution

As India marches towards a centenary of freedom from colonial rule, its capital markets and the role of the regulator have to evolve commensurately. SEBI has some disadvantages. In the Indian financial system, banks are perceived to be superior to capital markets. Consequently, and due to its older history, the RBI is the premier regulator in the country. SEBI, which is newer and younger, and without a strong institutional depth of talent, is seen as secondary to the RBI. The chairman of SEBI is the rank of secretary, government of India (GoI) while the RBI governor enjoys the rank of cabinet secretary.

Appointments at the RBI up to the level of the executive director (ED) are internal, and it enjoys operating freedom on all matters except monetary policy, which is determined by the Monetary Policy Committee. In contrast, the success or failure of SEBI rests disproportionately on the dynamism and agenda of the chairman, who is an external nominee. For years, it has been staffed by officers on secondment from other arms of the government. Though these numbers have come down, there is no substitute for nurturing, recognising and rewarding organic and home-grown talent.

SEBI’s extraordinary work in bringing market efficiency and transparency is short-changed in other areas as well, particularly in corporate disclosure, which is not directly regulated by it. Around the world, the corporate surveillance function of a regulator is adjacent to the market surveillance one, which analyses balance sheets, disclosures, and identifies bad practices like fraud and embezzlement. The Securities and Exchange Commission in the United States, for example, enforces corporate disclosure and has the rights to punish companies that do not comply with these rules. As the equity market regulator, interested in efficient and well-governed markets, SEBI too must be urgently vested with the corporate surveillance function to logically round off its regulatory role.

These disparities in resources and status must be overcome for, in the future, capital markets will become more important than banks in the Indian financial sector. That has been the experience of advanced nations.

India is a laggard when it comes to financial assets as savings. Physical assets remain the preferred mode of saving. Equities are just 5% of financial assets and most financial savings are held as bank deposits in savings or long-term fixed deposit accounts. An empowered SEBI can change this.

An unintended outcome of creating a world-class secondary trading market is the encouragement of  short-termism among market participants, especially retail investors in India.  The minute-by-minute calculation of investment profits and losses makes equities appear more volatile than a non-transparent market like real estate! Investor education needs to focus on the success of patient, long- term investment over short-term trading, with case studies from Warren Buffett, or Rakesh Jhunjhunwala, closer home.

The Indian capital market needs long-term investors like pension, provident and insurance funds. The education of retail investors must be a constant endeavour so that more ordinary citizens can enter the markets with confidence.

As the Indian government begins to withdraw in earnest from operating in the commercial sphere, more public sector enterprises will be listed and owned by the public. This will add depth and breadth to the market. The formalisation of this largely informal economy will, over time, create several medium and large enterprises that will tap the capital market for funding and listing – a vast improvement over the current scenario where there are too many unproductive micro and small enterprises.

Finally, no capital market is complete without the presence of a debt market of size and depth. India does not have one. The government of India still practises financial repression and appropriates most of the country’s savings (which is lodged with the banking system) through mandatory investments by banks in government securities. It further creates interest rate distortions by sponsoring and subsidising small savings schemes that offer unhealthy and unfair competition to banks. With their higher interest rates on savings and an implicit or explicit government guarantee, these actively inhibit the development of a vibrant debt market.

At around 5,800 listed companies, among the stock exchanges tracked by the Federation of International Stock Exchanges globally, BSE has the highest number of listings.[5] Further, between BSE and NSE, India has a little under 7,000 stocks listed in them although there could be a considerable number of common listings between the two exchanges. A market with these numbers must be broad and efficient. Such a market must have an empowered regulator – a model for equity markets everywhere as they undergo dramatic changes in technology, investor behaviour and trading patterns. The road ahead may be long, but the roadmap is clear.

K.N. Vaidyanathan is Advisor and Adjunct Senior Fellow, Geoeconomics Studies at Gateway House: Indian Council on Global Relations, Mumbai and EVP & Chief Risk Officer of Mahindra and Mahindra, India. He was the Executive Director at the Securities & Exchange Board of India.

Dr. V. Anantha-Nageswaran is Adjunct Senior Fellow, Geoeconomics Studies, at Gateway House.

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[1] Mirchandani, Sanam, ‘India is on the road to have blockbuster IPO year’, The Economic Times, 15 August 2017, <>

[2] Rakesh Mohan and Partha Ray: ‘Indian Financial Sector: Structure, Trends and Turns, IMF Working Paper (WP/17/7), January 2017 (

[3] SEBI was given statutory powers in April 1992 through the SEBI Act, 1992

[4] “According to the statistics of the World Federation of Exchanges (WFE), in terms of the number of trades in equity shares, the NSE ranks first globally, with 1,449,227 thousand trades at the end of December 2013. The NSE retained its top position in the first half of 2014 as well, with 1,298,294 thousand trades in January-September 2014. However, as of end September 2015, the NSE slipped to third position in terms of number of trades in equity shares.” (Source: Indian Securities Market – a review 2015, National Stock Exchange, India)

[5] World Federation of Exchanges, WFE Annual Statistics Guide, (London: WFE, 2016), <>, (Accessed on 24 August 2017)

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