Unit-II

Introduction to Financial Market

in India
(Role and Importance of Financial Markets)

By
Rahul Soren
Sonal
 Introduction to Financial Market in India

A financial market is a marketplace where buyers and sellers trade Financial Instrument ,
such as stocks,bonds, currencies, and derivatives.

Role and Importance in the Economy

Capital Formation Risk Management

Price Discovery Economic Growth

Liquidity
Capital Formation: Businesses and governments raise capital to fund their operations and
investments through financial markets. By issuing stocks, bonds, and treasury bills,
businesses gain the capital for investing in research and development
Risk Management: This market helps in risk management. Investors can manage risks by
diversifying their investments across different asset classes, such as stocks, bonds, and
commodities. Derivatives, such as futures and options contracts, provide investors with
additional tools for hedging against potential losses.
Price Discovery: Financial markets provide a platform for buyers and sellers to come
together to determine the prices of financial assets. This price discovery process ensures that
financial assets are priced efficiently based on the supply and demand for them.
Liquidity: Financial markets provide investors with the ability to buy and sell financial assets
quickly and easily. This liquidity makes it possible for investors to exit positions and access
their capital when needed, which is critical for managing cash flow and minimizing risk.

Economic Growth: Financial markets promote economic growth by providing the capital and
liquidity that businesses need to invest in new products, services, and technologies. This
investment helps to drive innovation, create jobs, and boost productivity.
 Types of Financial Market

Money Market

Capital Market

Debt Market

Currency market
Money market: is a market for short-term, highly liquid securities. It caters to immediate
cash requirements of the economy and helps mobilise funds across different sectors.
Money market interest rates serve as a benchmark for other debt securities and are
used by RBI and the government to frame monetary policy.

Major players in the money market include the Reserve Bank of India (RBI), banks,
NBFCs, acceptance houses, mutual fund houses and All India Financial Institutions (AIFI).
Individuals, firms, companies and other institutions may invest in treasury bills and
other money market instruments.

Capital market: is a market for long-term investments that helps businesses raise funds
for long-term projects.Capital markets in India are highly regulated and organised and
have the potential to give good returns in the long run.
Parameter Money Market Capital Market

function Short-term credit facilities Long-term credit facilities

Market type Informal Regulated/ formal

To turn into a part of the asset base of

Purpose For working capital requirements
the organisation

Categories None Primary and Secondary

Risk Low High

Instruments CDs, T-Bills, Commercial Papers, etc. Stocks and bonds

Return Consistent Market-linked

 Factors Affecting Financial Markets

Economic Indicator

Political Stability

Global Events
Economic Indicator

GDP : GDP measures the total values of goods and services produced within a country over a
specific period.
It is a primary indicator of economic health High GDP growth rates typically signal a robust
economy, positively influencing financial markets.

Inflation Rate: The inflation rate measures the rate at which the general price level of goods and
services is rising.
Moderate inflation indicates a growing economy, but high inflation can erode purchasing power
and negatively impact financial markets.

Unemployment Rate: The unemployment rate represents the percentage of the labor forces that
is unemployed and actively seeking employment.
High unemployment indicates economic distress, while low employment suggests economic
stability and growth, which can positively affect financial markets.
Political Stability
Political stability refers to the durability and integrity of a current government regime and
predictability of its policies. its encompasses the absence of significant conflicts, frequent
changes in government, or large-scale civil unrest.

Confidence and Predictability: Stable political environments foster confidence among investor
and businesses. Predictable government actions and policies reduce uncertainity, encouraging
investment and economic growth

Economic Performance: Stable political environments generally leads to better economic

performance. Governments can implement effective policies for economic development, which in
turn positively affects financial markets.

International Relationship: Political stability often correlates with strong international relations,
which can enhance trade, investment, and economic cooperation. These international linkages
further strengthen financial markets
Global Events
Pandemics::
Examples: COVID-19 Pandemic.
Impact: Pandemics can cause widespread economic disruptions, affecting supply chains,
reducing consumer demand, and leading to significant market volatility. Governments and central
banks often respond with fiscal and monetary stimulus to mitigate the impact.

Technological Innovations:
Examples: Rise of Cryptocurrencies, Advances in Artificial Intelligence.
Impact: Technological innovations can create new investment opportunities and disrupt existing
industries. The rise of digital currencies like Bitcoin has introduced new asset classes, while AI
advancements impact sectors like finance, healthcare, and manufacturing.
Linkages Between Economy and Financial Market
Economic Indicator and Financial Market

Financial Market Indicators and the Economy

Policy Interactions

Global Linkages
1. Economic Indicators and Financial Markets

GDP Growth
Impact on Stock Markets: Strong GDP growth usually leads to higher corporate profits,
boosting stock prices. Conversely, weak GDP growth can depress stock prices.
Bond Markets: Rapid GDP growth can lead to inflationary pressures, potentially resulting in
higher interest rates and lower bond prices. Sluggish growth might lead to lower interest rates,
benefiting bond prices.
Inflation
Stock Markets: Moderate inflation can be positive, indicating economic growth, but high
inflation can erode corporate profits and consumer purchasing power, negatively impacting
stock markets.
Bond Markets: High inflation leads to higher interest rates, reducing the value of existing
bonds. Conversely, low inflation generally supports higher bond prices.
2. Financial Market Indicators and the Economy

Stock Market Performance

Wealth Effect: Rising stock markets increase household wealth, encouraging consumer
spending and boosting economic activity.
Business Investment: Strong stock performance can make it easier for companies to raise
capital, promoting investment and expansion.

Bond Market Performance

Interest Rates: Bond yields influence borrowing costs for consumers and businesses. Lower
yields can spur borrowing and investment, while higher yields can dampen economic activity.
Government Fiscal Health: Government bond yields reflect investor confidence in a country's
fiscal stability. High yields can increase government borrowing costs and impact public
spending.
3. Policy Interactions

Monetary Policy
Interest Rates: Central banks, like the Reserve Bank of India (RBI), adjust interest rates to
control inflation and stimulate or cool down the economy. These changes directly impact
financial markets.
Quantitative Easing: Central bank policies of buying financial assets can lower yields and boost
asset prices, impacting economic activity.

Fiscal Policy
Government Spending and Taxation: Fiscal policies influence economic growth, impacting
corporate profits and financial markets. Expansionary fiscal policies can stimulate growth and
boost markets, while contractionary policies can have the opposite effect.
5. Global Linkages

Global Trade

Export-Import Balance: The performance of financial markets can affect a country's trade
balance. Strong markets can strengthen a currency, impacting export competitiveness.
Global Economic Conditions: Financial markets are interconnected globally. Economic
conditions and market performance in major economies like the US, China, and the EU can
influence Indian financial markets and economic conditions.
Integration of Indian Financial Market with Global
Financial Market
The integration of Indian financial markets with global financial markets has been an ongoing
process, significantly impacting the country's economic landscape. This integration is evident
across various dimensions, including capital flows, market regulations, technological
advancements, and the participation of international investors.

Key Aspects of Interagtion

1. Capital Flows
2. Regulatory Harmonization
3'Technological Advancements
4' Global Economic Integration
1. Capital Flows

Foreign Direct Investment (FDI)

Liberalization Policies: Since the 1990s, India has progressively liberalized its FDI policies,
allowing greater foreign investment in various sectors. This has led to increased inflows of
capital, technology transfer, and job creation.
Economic Growth: FDI has contributed to the growth of key sectors such as manufacturing,
services, and infrastructure, boosting overall economic development.
Foreign Portfolio Investment (FPI)
Equity and Debt Markets: Indian stock and bond markets have seen significant
participation from foreign institutional investors (FIIs). The inclusion of Indian stocks in
global indices like MSCI and FTSE has also attracted more international investors.
Market Volatility: FPIs can lead to increased market volatility as global risk sentiment shifts.
For instance, geopolitical tensions or changes in US Federal Reserve policies can result in
capital outflows from Indian markets.
2. Regulatory Harmonization

Market Regulations
Securities and Exchange Board of India (SEBI): SEBI has implemented several measures to
align Indian market practices with global standards, enhancing transparency, investor
protection, and market efficiency.
International Collaboration: India collaborates with international regulatory bodies such as
the International Organization of Securities Commissions (IOSCO) to adopt best practices
in market regulation.

Banking and Financial Services

Basel Norms: Indian banks have adopted Basel III norms for capital adequacy, liquidity, and
leverage, aligning with global banking standards to enhance financial stability.
Cross-Border Banking: Indian banks have expanded their presence globally, while foreign
banks have established operations in India, fostering integration.
3. Technological Advancements

Financial Technology (FinTech)

Digital Payments: India's rapid adoption of digital payment systems, such as the Unified
Payments Interface (UPI), has positioned it as a leader in financial technology, attracting
global interest and investment.
Blockchain and AI: Indian financial institutions are increasingly using blockchain and
artificial intelligence for transactions, risk management, and customer service, aligning with
global technological trends.

Stock Exchanges
Global Connectivity: Indian stock exchanges like BSE and NSE have established
connectivity with global exchanges, facilitating cross-border trading and dual listings.
Algorithmic Trading: Adoption of algorithmic trading and high-frequency trading in India
reflects global trading practices, enhancing market efficiency and liquidity.
4. Global Economic Integration
Trade and Investment Agreements
Bilateral and Multilateral Agreements: India has entered into several trade and investment
agreements, including Free Trade Agreements (FTAs) and Comprehensive Economic
Partnership Agreements (CEPAs), promoting cross-border economic integration.
Global Value Chains: Participation in global value chains has increased as Indian companies
engage in international trade and investment, further integrating the economy with global
markets.
Economic Policies and Global Influence
Policy Coordination: India's economic policies are increasingly influenced by global
economic conditions and policies of major economies like the US, EU, and China. This
includes adjustments in monetary policy, trade tariffs, and regulatory frameworks.
Global Financial Institutions: Active participation in global financial institutions like the
International Monetary Fund (IMF), World Bank, and Asian Development Bank (ADB) helps
India align its financial policies with global norms and benefit from international financial
support.