Role of Financial Market and Securities Market in Economic Growth

Introduction

Financial system comprises of all financial markets, instruments and institutions. It provides for
the flow of funds from surplus sources to where there is shortage. This is mainly done through
two main sources; debt financing as well as equity financing. For the purpose of economic
development, every nation requires a strong financial system. It is closely linked to the economic
performance.

Role of Financial Market in Economic Growth

The financial system is particularly important in reallocating capital and thus providing the basis
for the continuous restructuring of the economy that is needed to support growth.

India, being a developing nation need large scale expenditure for improving our infrastructure.
Equity is the risk free source of finance for new and innovative firms. The market capitalization
of the equity market (National Stock Exchange) has grown from approximately ` 6.5 trillion in
2000-01 to approximately ` 60 trillion in 2009-10 and further to approximately ` 61 trillion in
2011-12. Market capitalization here, refers to market value of all of a company s outstanding
shares.

The banking sector also has an essential role to play with respect to the allocation of funds to the
most profitable investment opportunities. The credit to GDP ratio, which stood at about five per
cent in 1950-51, improved to about 25 per cent in 2000-01 and further to about 52 per cent at the
end of 2011-12.

With a large section of population underprivileged, the welfare commitments of the Indian state
have to be supported by a large government-borrowing program. The outstanding government
debt issued to such sections has grown from ` 4.3 trillion in 2000-01 to ` 29.9 trillion in 2012-13.
This has resulted in huge developments for the underprivileged section.

Yet another source for finance is the debt market. Corporate bonds support them and provides
and additional avenue for raising resources. This helps them to lower dependency on bank
finance. A well-developed debt market enables efficient pricing of risk, promotes product
innovations and leads to greater financial stability.

Further policies made in the financial market like monetary policy (CRR, SLR etc) has
contributed to economic growth. They have helped in maintaining steady medium-term price
stability (rupee against dollar). Such a policy will be beneficial, as it will minimize the adverse
effects of inflation and high inflation uncertainty. It not only creates a climate for higher
economic activity over the medium term, but also reduces the economic and social inequalities.
In addition, in an environment of low inflationary expectations, inflation risk becomes relatively
less important as a determinant of financial prices. Ultimately, this results in a more efficient
allocation of financial resources.

Supervision is the guardian of financial stability, which in turn crucially determines the
capability of the financial system to allocate resources efficiently and absorb liquidity shocks.
The Securities and Exchange Board of India (SEBI), being the main regulator of this segment,
along with Reserve Bank has taken steps, such as, introducing Credit Default Swaps (CDS) to
manage credit risk, repo in corporate bonds to enable funding of positions etc to ensure the
smooth functioning of the market leading to growth.