The capital market: Then and now

News:  Public issues in capital markets are the route for corporate finance.

How the trends of capital markets in India are changing post-liberalisation?

Firstly, the share of the private corporate sector in Gross Fixed Capital Formation (GFCF) has increased sharply.

Secondly, the share of the public sector in GFCF has fallen. Further, the public sector, which accounts for nearly half the investment, is also now more dependent on market-based funding than on budgetary support.

Thirdly, the growing involvement of the private sector in infrastructure investments, which were largely budget-funded public sector projects in the pre-liberalization phase.

For instance, now the private sector owns;

– Practically all the renewable energy power capacity,

– Nearly 40 percent of the thermal capacity and

– It is involved in about 1,000 public-private-partnership (PPP) projects, mainly for roads and ports.

What are the steps taken to boost financial systems in the post-liberalization era?

The easing of the issue of shares by private companies.

Easing of trading: The establishment of the National Stock Exchange that introduced screen-based trading and the dematerialization of shares.

Opening up the mutual fund market to private asset management companies.

Opening of financial intermediation to private entities: the banking sector was opened to new private sector banks. Along with this, non-banking financial institutions have become a significant force in the capital market.

Liberalization of rules for foreign direct and portfolio investment.

Further, the spread of telecommunications and the internet and the spread of internet banking and digital payment systems has also boosted the financial system in India.

What further reforms are needed to strengthen the financial systems in India

First, the main issue, pending for decades, is the health of public sector banks. A large accumulation of NPA’s is affecting the health of PSB’s. Further, the finance ministry and the public sector banks need to be separated to allow them to function as market entities.

Second, the flow of commercial finance from the capital market (public issue of shares) is inadequate/ negligible. For instance, taking an average of the three years ending 2019-20, only 2 percent of the flow of commercial finance came from public issues. The major source remains bank credit, which accounted for 49 percent of the flows. This needs to be addressed.

What is the reason for low dependence on the public issue?

A family-dominated corporate management structure, and the reluctance to dilute control, is the reason. This has to change if India is to make a transition to a proper market-based economy.

In the more mature market economies, this happened when corporate ownership widened with indirect share purchases by retail investors through mutual funds and pension funds.

What are the suggestions to boost financial resources in India?

First, there is a need for formal financial arrangements for non-corporate enterprises and households. According to a 2018 study, out of the total debt of Rs 69.3 trillion incurred by the micro, small and medium enterprises (MSMEs) only ₹10.9 trillion came from banks and other formal sources.

Second, domestic venture funds are required to fund MSME vendors and technology or business-model-driven start-ups in manufacturing and in socially desirable activities.

Source: This post is based on the article “The capital market: Then and now” published in Business Standard on 29^th Dec 2021.