The
importance of capital market can only be ascertained if we look at the Indian
Financial System as a whole. Indian Financial System has many constituents
amongst which capital market is one. To start with financial system, it
represents flow of money in the nation. The main aim of any financial system is
to channelize the funds from a surplus party to a deficit party.
The money
comes from where & goes to whom, is the crux. Therefore,
two important aspects of the financial system are “Suppliers” of the fund & “Seekers” of the fund. Having stated
this one would like to see how money flows in a country which is shown below;
The
diagram above is called a circular flow of money in an economy. In the above
diagram it is shown that households consume from the markets of goods and services
by paying money in exchange, which then flows to firms. From firms money flows
down to factors of production as salaries, rent, interest, compensation. This
money is nothing but income for households which come back to them. Here comes
the importance of financial markets. All of us does not consume everything at
one go. We save something or the other for future requirements. These savings
are called private savings.
Where
do we park these funds? These funds are then invested in banks, financial
institutions such as NBFCs, in corporate, Bond markets & Gilt-edged markets
and other places. All these combined known as ‘Financial System’ that routes
the money from suppliers of funds to seekers of funds. Almost everything is
linked to it. Financial system is a set
of complex, inter-mixed financial institutions, agents, practices, markets,
claims in an economy for performing economic activities. It is a link between
savings and investment for the creation of new wealth. Indian Financial System
is divided as follows:
Importance of Capital market:
It
is a well known fact that a country grows when its GDP grows. All the tension
that is currently hovering on India’s growth v/s inflation story boils down to
one thing. By how much is India Inc going to grow this year? Will it be 5%,
4.5% or at some rate higher than this? Growth is nothing but GDP growth. GDP of
a country grows, only when you produce and consume. Imagine where would Bharti
Airtel get huge sum of money to build towers for communication? How would
Reliance Power, Tata Steel, and Mahindra & Mahindra do business if they
don’t get the money? Money required for this is to the tune of thousand of
crores and not some lakhs or crores. It is the common public of India that
provide with the money. Financial markets only routes the money. It acts as an
intermediary nothing else. If one
recalls the 1991 crisis whereby liberalization took place, for the very first
time FDI came into picture. It was due to the existence of capital market that
such inflow was possible. Even today, foreign nationals are pouring in money,
which is required for GDP growth. How could have this been possible, if capital
market didn’t existed.
The
other thing is banks have had always a constraint of providing investors with
higher returns. FD has always been seen as a benchmark in terms of safe
returns. A return of safe 8-9.75% would attract those who are retired and those
who are risk averse. But what about those investors who have an appetite for
higher risks so that they can get maximum returns from their investments. Had
capital market been not there, these kinds of investors would never have made
money. Let us look at the average 10 year returns from capital market v/s bank
returns
Particulars
|
10 years Average return
|
Bank
FDs
|
7.07%
|
Equity
markets
|
18.00%
|
Debt
markets
|
8.18%
|
Gold
|
17.00%
|
Exhibit-3
Just
imagine the kind of returns one would have lost had there been no capital
market. The initiative of savings that supports GDP on growth trajectory has
been commendable and much of the credit for such initiative goes to capital
market. Banks on other hand has its own limitations. If one talks about
pre-1997 era when Glass Steagall act condemned banks to invest in riskier
propositions, it was capital market that helped these new ventures to raise
money. On the other hand apart from project financing, entire debt funding is
very cynical on a company’s part. They are required to raise some funds as
Equity, again none other than capital market that would help.
Therefore,
only if new businesses are set up, new products are being made and they are
consumed. If the economy produces and consumes then only the economy can
develop. They can only develop if the funds for production are being provided.
These funds in turn can only be provided if the savings are routed properly. It
can only happen if you have the intermediary in form of capital markets. Now in
order to illustrate the GDS (Gross domestic Savings) as a %age of GDP (Gross
Domestic Product), below is the exhibit shown. 
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The
blue line shows the world’s gross savings (GDS) as a ratio of world’s GDP
whereas the red line shows the India’s GDS ratio to its GDP. Due to the boom in
the market in early and mid 2000s , the line appear to be on a rising note
falling in the later half due to sub-prime crisis and again bouncing back.
Almost 80% of this savings has been invested in either bond markets, equities
markets or commodities market and rest 20% into bank FDs. Although this ratio is
far above than world’s savings, but according to Indian management guru Mr.
Gurcharan Das, the domestic investment in equities market are below standards
when compared to Chinese or Brazilian economies. This shows the future of
capital markets. They have a long way to go.
FDIs,
FIIs and other investment from foreign nationals show the robustness of the
capital markets. In a nutshell the importance of Capital markets can be
described as:
Mobilisation
of Savings Capital
Formation Provision
of Investment avenue Speeding
up Economic Development Proper
regulation of funds Steady
availability of funds
Conclusion:
The lack of an advanced and vibrant capital market can lead
to under-utilization of financial resources. The developed capital market also
provides access to the foreign capital for domestic industry. If anything that
can create a pull of that uninvited savings that is only the new avatar of
capital market. Thus capital market definitely plays a constructive role in the
overall development of an economy.
References:
