CHAPTER 1

1.1EXECUTIVE SUMMERY

India embarked on reintegration with the world economy in the early 1990s. At first, a

certain limited opening took place emphasising equity flows by certain kinds of foreign

investors. This opening has had myriad interesting implications in terms of both

microeconomics and macroeconomics. A dynamic process of change in the economy and

in economic policy then came about, with a co-evolution between the system of capital

controls, macroeconomic policy, and the internationalisation of firms including the

emergence of Indian multinationals. Through this process, de facto openness has risen

sharply. De facto openness has implied a loss of monetary policy autonomy when

exchange rate pegging was attempted. The exchange rate regime has evolved towards

greater exibility.

1.2 OBJECTIVES OF THE STUDY

To study the impact of Globalization of Financial Market in India

To know whether the globalization of Financial Market is really good for India or

not.

To study the concept of Globalization of Financial Market.

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1.3 RESEARCH METHODOLOGY

This report is based on primary as well as secondary data, however the secondary data

collection was given more importance since it has extracted from the reliable sources.

Primary data is collected for the purpose of obtaining investor’s views and opinions as

stated above in the objectives.

Data Sources: Secondary data is used only for the reference and information. Research

has been done by primary data collection and primary data has been collected by

interacting with various people. The secondary data has been collected through various

books and websites.

Statistical Techniques Used: Statistical calculations have been made, making general use of Microsoft Excel on the computer. The Statistics and Graphs / Tables are based on Secondary & primary data extracted from various resource

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CHAPTER 22.1 Introduction

Financial system refers to the set of institutions, instruments and markets which foster

savings and channels them to their most efficient use. In every economy, we find some

system to mobilize the surplus monetary resources from various sectors of the economy

and allocate the same to the needy sectors. The system consists of individuals,

intermediaries, markets and users of savings. Economic activity and growth are greatly

facilitated by the existence of a financial system developed in terms of efficiency of the

market in mobilizing savings and allocating them among competing users. The group of

different entities that are engaged in the task of garnering the money resources available

in an economy will constitute the financial system. Depending upon the structure and

objective of each entity, the role of the particular entity will address to certain defined

sectors or confine its functions within specified contours.

The transformation of Savings into Investments and Consumption is thus facilitated by

the active role played by the financial system. The process of transformation is aided by

various types of financial assets suiting the individual needs and demands of both the

investors and spenders. The offering of these diverse types of financial assets is supported

by the role of financial intermediaries who invariably intermediate between these two

segments of investors and spenders. Examples of intermediaries are banks, financial

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institutions, mutual funds etc. The place where these activities take place could be taken

to connote financial market.

Well developed financial markets are required for creating a balanced financial system in

which both financial markets and financial institutions play important role. Deep and

liquid markets provide liquidity to meet any surge in demand for liquidity in times of

financial assets. Such markets are also necessary to derive appropriate reference rates for

pricing financial assets.

2.2 Structure of the Financial System Financial system consists of markets, individuals or savers, intermediaries and users of

savings. In the present global context economic activity and growth are facilitated by the

existence of financial system developed in term of efficiency of the markets in mobilizing

savings.

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Financial Institutions:

In financial economics, a financial institution is an institution that provides financial

services for its clients or members. Probably the most important financial service

provided by financial institutions is acting as financial intermediaries. Most financial

institutions are regulated by the government.

Financial institutions can be classified as banking and non- banking financial institutions.

Banking institutions are creators of credit while non- banking financial institutions are

purveyors of credit. While the liabilities of banks are part of the money supply, this may

not be true of non banking financial institutions.

Financial Market:

Financial markets are a mechanism enabling participants to deal in financial claims. The

markets also provide a facility in which their demands and requirements interact to set a

price for such claims.

The main organized financial markets in India are the money market and capital market.

The first is a market for short-term securities while the second is a market for long term

securities, that is, securities having a maturity period of one year or more.

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Financial Instruments:

A financial instrument is a tradable asset of any kind; either cash, evidence of an

ownership interest in an entity, or a contractual right to receive or deliver cash or another

financial instrument.

According to IAS 32 and 39, it is defined as "any contract that gives rise to a financial

asset of one entity and a financial liability or equity instrument of another entity.

Financial Instruments may be primary or secondary securities. Primary securities are also

termed as direct securities as they are directly issued by the ultimate borrowers of funds

to the ultimate savers. Examples of primary or direct securities include equity shares and

debentures. Secondary securities are also referred to as indirect securities as they are

issued by the financial intermediaries to the ultimate savers. Bank deposits, mutual fund

units, and insurance policies are secondary securities.

Financial instruments differ in terms of marketability, liquidity, reversibility, type of

option, return, risk and transaction costs. Financial instruments help the financial markets

and the financial intermediaries to perform the important role of canalizing funds from

leaders.

Financial Services:

Financial services are the economic services provided by the finance industry, which

encompasses a broad range of organizations that manage money, including credit

unions, banks, credit

card companies, insurance companies, accountancy companies, consumer

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finance companies, stock brokerages, investment funds and some government sponsored

enterprises.

As of 2004, the financial services industry represented 20% of the market

capitalization of the S&P 500 in the United States. The U.S. finance industry comprised

only 10% of total non-farm business profits in 1947, but it grew to 50% by 2010. [2] Over

the same period, finance industry income as a proportion of GDP rose from 2.5% to

7.5%, and the finance industry's proportion of all corporate income rose from 10% to

20%.

2.3 Role of Financial Market

Saving mobilization:

Obtaining funds from the savers or surplus units such as household individuals, business

firms, public sector units, central government, state governments etc. is an important role

played by financial markets.

Investment:

Financial markets play a crucial role in arranging to invest funds thus collected in those

units which are in need of the same.

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National Growth:

An important role played by financial market is that, they contributed to a nations growth

by ensuring unfettered flow of surplus funds to deficit units. Flow of funds for productive

purposes is also made possible.

Entrepreneurship growth:

Financial market contributes to the development of the entrepreneurial claw by making

available the necessary financial resources.

Industrial development:

The different components of financial markets help an accelerated growth of industrial

and economic development of a country, thus contributing to raising the standard of

living and the society of well-being.

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2.4 Functions of Financial Market

Intermediary Functions: The intermediary functions of a financial markets include the

following:

Transfer of Resources: Financial markets facilitate the transfer of real economic

resources from lenders to ultimate borrowers.

Enhancing income: Financial markets allow lenders to earn interest or dividend on their

surplus invisible funds, thus contributing to the enhancement of the individual and the

national income.

Productive usage: Financial markets allow for the productive use of the funds borrowed.

The enhancing the income and the gross national production.

Capital Formation: Financial markets provide a channel through which new savings

flow to aid capital formation of a country.

Price determination: Financial markets allow for the determination of price of the traded

financial assets through the interaction of buyers and sellers. They provide a sign for the

allocation of funds in the economy based on the demand and supply through the

mechanism called price discovery process.

Sale Mechanism: Financial markets provide a mechanism for selling of a financial asset

by an investor so as to offer the benefit of marketability and liquidity of such assets.

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Information: The activities of the participants in the financial market result in the

generation and the consequent dissemination of information to the various segments of

the market. So as to reduce the cost of transaction of financial assets.

Financial Function

Providing the borrower with funds so as to enable them to carry out their

investment plans.

Providing the lenders with earning assets so as to enable them to earn wealth by

deploying the assets in production debentures.

Providing liquidity in the market so as to facilitate trading of funds.

it provides liquidity to commercial bank

it facilitate credit creation

it promotes savings

it promotes investment

it facilitates balance economic growth

it improves trading floors

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CHAPTER 3

3.1 Indian Financial Market

Financial system refers to the set of institutions, instruments and markets which foster

savings and channels them to their most efficient use. In every economy, we find some

system to mobilize the surplus monetary resources from various sectors of the economy

and allocate the same to the needy sectors. The system consists of individuals,

intermediaries, markets and users of savings. Economic activity and growth are greatly

facilitated by the existence of a financial system developed in terms of efficiency of the

market in mobilizing savings and allocating them among competing users. The group of

different entities that are engaged in the task of garnering the money resources available

in an economy will constitute the financial system. Depending upon the structure and

objective of each entity, the role of the particular entity will address to certain defined

sectors or confine its functions within specified contours.

The transformation of Savings into Investments and Consumption is thus facilitated by

the active role played by the financial system. The process of transformation is aided by

various types of financial assets suiting the individual needs and demands of both the

investors and spenders. The offering of these diverse types of financial assets is supported

by the role of financial intermediaries who invariably intermediate between these two

segments of investors and spenders. Examples of intermediaries are banks, financial Page | 17

institutions, mutual funds etc. The place where these activities take place could be taken

to connote financial market.

Well developed financial markets are required for creating a balanced financial system in

which both financial markets and financial institutions play important role. Deep and

liquid markets provide liquidity to meet any surge in demand for liquidity in times of

financial assets. Such markets are also necessary to derive appropriate reference rates for

pricing financial assets.

3.2 Structure of Indian Financial Market

India has a financial system that is regulated by independent regulators in the sectors of

banking, insurance, capital markets, competition and various services sectors. In a

number of sectors Government plays the role of regulators.  

Ministry of Finance, Government of India looks after financial sector in India. Finance

Ministry every year presents annual budget on February 28 in the Parliament. The annual

budget proposes changes in taxes, changes in government policy in almost all the sectors

and budgetary and other allocations for all the Ministries of Government of India. The

annual budget is passed by the Parliament after debate and takes the shape of law.

Reserve bank of India (RBI) established in 1935 is the Central bank. RBI is regulator for

financial and banking system, formulates monetary policy and prescribes exchange

control norms. The Banking Regulation Act, 1949 and the Reserve Bank of India Act,

1934 authorize the RBI to regulate the banking sector a. 

India has commercial banks, co-operative banks and regional rural banks. The

commercial banking sector comprises of public sector banks, private banks and foreign

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banks. The public sector banks comprise the ‘State Bank of India’ and its seven associate

banks and nineteen other banks owned by the government and account for almost three

fourth of the banking sector. The Government of India has majority shares in these public

sector banks.

India has a two-tier structure of financial institutions with thirteen all India financial

institutions and forty-six institutions at the state level. All India financial institutions

comprise term-lending institutions, specialized institutions and investment institutions,

including in insurance. State level institutions comprise of State Financial Institutions and

State Industrial Development Corporations providing project finance, equipment leasing,

corporate loans, short-term loans and bill discounting facilities to corporate. Government

holds majority shares in these financial institutions. 

Non-banking Financial Institutions provide loans and hire-purchase finance, mostly for

retail assets and are regulated by RBI.  

Insurance sector in India has been traditionally dominated by state owned Life Insurance

Corporation and General Insurance Corporation and its four subsidiaries. Government of

India has now allowed FDI in insurance sector up to 26%. Since then, a number of new

joint venture private companies have entered into life and general insurance sectors and

their share in the insurance market in rising. Insurance Development and Regulatory

Authority (IRDA) is the regulatory authority in the insurance sector under the Insurance

Development and Regulatory Authority Act, 1999. 

RBI also regulates foreign exchange under the Foreign Exchange Management Act

(FERA). India has liberalized its foreign exchange controls. Rupee is freely convertible

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on current account. Rupee is also almost fully convertible on capital account for non-

residents. Profits earned, dividends and proceeds out of the sale of investments are fully

repatriable for FDI. There are restrictions on capital account for resident Indians for

incomes earned in India.

Securities and Exchange Board of India (SEBI) established under the Securities and

Exchange aboard of India Act, 1992 is the regulatory authority for capital markets in

India. India has 23 recognized stock exchanges that operate under government approved

rules, bylaws and regulations. These exchanges constitute an organized market for

securities issued by the central and state governments, public sector companies and

public limited companies. The Stock Exchange, Mumbai and National Stock Exchange

are the premier stock exchanges. Under the process of de-mutualization, these stock

exchanges have been converted into companies now, in which brokers only hold minority

share holding. In addition to the SEBI Act, the Securities Contracts (Regulation) Act,

1956 and the Companies Act, 1956

regulates the stock markets. The

financial markets can be classified

as Money Market and Capital

Market on the basis of the

instruments in which they deal.

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3.3 Capital Market

Capital Market may be defined as a market dealing in medium and long-term funds. It is

an institutional arrangement for borrowing medium and long-term funds and which

provides facilities for marketing and trading of securities. So it constitutes all long-term

borrowings from banks and financial institutions, borrowings from foreign markets and

raising of capital by issue various securities such as shares debentures, bonds, etc. In the

present chapter let us discuss about the market for trading of securities.

The market where securities are traded known as Securities market. It consists of two

different segments namely primary and secondary market. The primary market deals with

new or fresh issue of securities and is, therefore, also known as new issue market;whereas

the secondary market provides a place for purchase and sale of existing securities and is

often termed as stock market or stock exchange.

Capital market can be classified into two types:

Primary Market

Secondary Market

Primary Market

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The primary market is where new securities (stocks and bonds are the most common) are

issued. The corporation or government agency that needs funds (the borrower) issues

securities to purchasers in the primary market. Big investment banks assist in this issuing

process. The banks underwrite the securities. That is, they guarantee a minimum price for

a business's securities and sell them to the public. Since the primary market is limited to

issuing new securities only, it is of lesser importance than the secondary market.

Secondary Market

The vast majority of capital transactions take place in the secondary market. The

secondary market includes stock exchanges (like the New York Stock Exchange and the

Tokyo Nikkei), bond markets, and futures and options markets, among others. All of

these secondary markets deal in the trade of securities.

Securities:

The term "securities" encompasses a broad range of investment instruments.

Investors have essentially two broad categories of securities available to them:

1. Equity securities (which represent ownership of a part of a company)

2. Debt securities (which represent a loan from the investor to a company

or government entity).

Equity securities:

Stock is the type of equity security with which most people are familiar. When investors

(savers) buy stock, they become owners of a "share" of a company’s assets and earnings.

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If a company is successful, the price that investors are willing to pay for its stock will

often rise and shareholders who bought stock at a lower price than stand to make a profit.

If a company does not do well, however, its stock may decrease in value and shareholders

can lose money. Stock prices are also subject to both general economic and industry-

specific market factors. In our example, if Carlos and Anna put their money in stocks,

they are buying equity in the company that issued the stock. Conversely, the company

can issue stock to obtain extra funds. It must then share its cash flows with the stock

purchasers, known as stockholders.

Debt securities:

Savers who purchase debt instruments are creditors. Creditors, or debt holders, receive

future income or assets in return for their investment. The most common example of a

debt instrument is a bond. When investors buy bonds, they are lending the issuers of the

bonds their money. In return, they will receive interest payments (usually at a fixed rate)

for the life of the bond and receive the principal when the bond expires. National

governments, local governments, water districts, global, national, and local companies,

and many other types of institutions sell bonds.

Second way of classifying Capital Market is as follows:

Types of capital Market:

Gilt – Edged Market

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Gilt - Edged market refers to the market for government and semi-government securities,

which carry fixed rates of interest. RBI plays an important role in this market.

Industrial Securities Market

It deals with equities and debentures in which shares and debentures of existing

companies are traded and shares and debentures of new companies are bought and sold.

Development Financial Institutions

Development financial institutions were set up to meet the medium and long-term

requirements of industry, trade and agriculture. These are IFCI, ICICI, IDBI, SIDBI,

IRBI, UTI, LIC, GIC etc. All These institutions have been called Public Sector Financial

Institutions.

3.4 Money Market

The money market is a market for short-term funds, which deals in financial assets whose

period of maturity is upto one year. It should be noted that money market does not deal in

cash or money as such but simply provides a market for credit instruments such as bills of

exchange, promissory notes, commercial paper, treasury bills, etc. These financial

instruments are close substitute of money. These instruments help the business units,

other organizations and the Government to borrow the funds to meet their short-term

requirement. Money market does not imply to any specific market place. Rather it refers

to the whole networks of financial institutions dealing in short-term funds, which

provides an outlet to lenders and a source of supply for such funds to borrowers. Most of

the money market transactions are taken place on telephone, fax or Internet. The Indian

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money market consists of Reserve Bank of India, Commercial banks, Co-operative

banks, and other specialized financial institutions. The Reserve Bank of India is the

leader of the money market in India. Some Non-Banking Financial Companies (NBFCs)

and financial institutions like LIC, GIC, UTI, etc. also operate in the Indian money

market.

Following are some of the important money market instruments or securities.

(a) Call Money: Call money is mainly used by the banks to meet their temporary

requirement of cash. They borrow and lend money from each other normally on a daily

basis. It is repayable on demand and its maturity period varies in between one day to a

fortnight. The rate of interest paid on call money loan is known as call rate.

(b) Treasury Bill: A treasury bill is a promissory note issued by the RBI to meet the

short-term requirement of funds. Treasury bills are highly liquid instruments, that means,

at any time the holder of treasury bills can transfer of or get it discounted from RBI.

These bills are normally issued at a price less than their face value; and redeemed at face

value. So the difference between the issue price and the face value of the treasury bill

represents the interest on the investment. These bills are secured instruments and are

issued for a period of not exceeding 364 days. Banks, Financial institutions and

corporations normally play major role in the Treasury bill market.

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(c) Commercial Paper: Commercial paper (CP) is a popular instrument for financing

working capital requirements of companies. The CP is an unsecured instrument issued in

the form of promissory note. This instrument was introduced in 1990 to enable the

corporate borrowers to raise short-term funds. It can be issued for period ranging from 15

days to one year. Commercial papers are transferable by endorsement and delivery. The

highly reputed companies (Blue Chip companies) are the major player of commercial

paper market.

(d) Certificate of Deposit: Certificate of Deposit (CDs) is short-term instruments issued

by Commercial Banks and Special Financial Institutions (SFIs), which are freely

transferable from one party to another. The maturity period of CDs ranges from 91 days

to one year. These can be issued to individuals, co-operatives and companies.

(e) Trade Bill: Normally the traders buy goods from the wholesalers or manufactures on

credit. The sellers get payment after the end of the credit period. But if any seller does not

want to wait or in immediate need of money he/she can draw a bill of exchange in favour

of the buyer. When buyer accepts the bill it becomes a negotiable instrument and is

termed as bill of exchange or trade bill. This trade bill can now be discounted with a bank

before its maturity. On maturity the bank gets the payment from the drawee i.e., the buyer

of goods. When trade bills are accepted by Commercial Banks it is known as Commercial

Bills. So trade bill is an instrument, which enables the drawer of the bill to get funds for

short period to meet the working capital needs.

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3.5 Euro Bond:A Euro Bond is an international bond which is issued on behalf of a multinational

corporation, international agency, or sovereign State to investors throughout the world.

They are normally issued as unsecured obligations of the borrowers. The instrument

floated by the Indian companies are commonly referred to as Foreign Currency

Convertible Bonds (FCCBs), FCBCs are basically equity linked debt securities, to be

converted into equity or depository receipt after specific period. Thus, a holder of FCBCs

has the option of either converting into equity or relating the bond. The FCBCs carry a

fixed rate of interest which is lower than the rate on any other similar non-convertible

debt instrument, and thus become attractive to the investors due to lower cost involved.

They can be marked conveniently and at the same time the issuer company can avoid any

dilution in earnings per share, unless the investors see improved earnings and prices for

the shares underlying the bonds. Also they can still be traded on the basis of underlying

equity value.

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The convertible bonds provide an opportunity to the holders to participate in the capital

growth of a company. Till the time he holds the bonds he gets a fixed return and in case

he chooses to convert them into equity, he makes a capital gain. Thus the convertible

bonds offer a mixture of the characteristics of fixed interest and equity investment.

3.6 Euro – equity Markets:

A Euro issue is an issue where the securities are issued in a currency of the country of

issue and the securities are sold internationally to corporate and private investors in

different countries. A euro issue is the securities are being issued, but the securities are

denominated in the currency of the country of issue and are aimed at domestic investors

in the country where the issue is made. Euro securities are transferable securities which

are to be underwritten and distribute by a syndicate.

The major benefit that a euro issue provides to the issuer companyis the ability to raise

funds at a lower cost. Average coupon rates on convertible bonds of five year maturity in

the Euro market are 2 ½ %to 4% as against the domestic long term interest rate of 14% or

more.

Also, a euro issue can e priced at par or even at a sight premium depending on the market

conditions. Besides these benefits, an issuer company can enlarge the market for its

shares through greater exposure and at the same time, enhance its image in the

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international market. International listing can provide increased liquidity for the

securities, thus making them more attractive to buyers. From an investor’s angle, a Euro

issue provides them a simple means to diversify their portfolio globally, and have access

to foreign markets which were closed to foreign investment until now.

3.7 Euro Currency Market:Euro Currency market is an international financial market specializing in the borrowing

and lending of currencies outside their countries of issue. The prefix ‘Euro’ thus refers to

external indicating that the market is not a constituent of the domestic financial system

and is thus free from the domestic banking regulation.

The Euro Currency market is primarily a post war phenomenon and came to be known as

Euro-dollar market. Thus the Euro dollar market is more broadly called the Euro currency

market as it also includes currencies other than the dollar such as pounds, Francs, Yen.

However, the Euro dollar portion of the euro Currency is the dominant one.

Constituents of Euro Currency Market:

1. Euro Currency Markets:

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Funds in the euro currency markets are funded by banks in the form of loans and

Merchant Bankers help in the loan syndication. To play in the international capital market

the major things that are important are the choice of currency and the choice of financial

instrument and in the selection of these, only the merchant banker’s skilla, expertise,

experience and resource position is reflected.

2. Euro Equity Market:

With liberalization having opened the floodgates of overseas market, more companies are

moving towards the mobilization of funds from the international market in the form of

Euro issues- GDRs (Global Depository Receipts). Reliance was the first company to do

so. More and more companies are opting for the euro issue route to mobilize resources.

This would inturn lead to Merchant Bankers to be fully conversant to deal in Euro issues.

However, there are some barriers which are restricting the growth of the Euro equity

market. The heavy cost and time involved in the investors, difficulty for investors in

making the decision to invest in a particular currency, standardizing of various systems,

complications of various regulations in other nations etc. are some of reasons. These

could be overcome once the Merchant Bankers develop expertise in these areas.

3. Euro Bond Market:

Merchant banker can enter into the international bond market as lead managers. There are

various centers which provide technical facilities and depending upon the borrower’s

country of origin, funds requirement, location of stock exchange. Euro Bonds are

required to be listed on one or more stock exchange for easy trading. To enter the area of Page | 30

international market, the Merchant Banker has to follow the two steps namely to

participate in international groupings and association with other Merchant Banks

operating in International market.

CHAPTER 4

4.1 Globalization of Indian Financial Market

India's integration into the world economy blossomed in First Globalisation. The

trade/GDP ratio rose from 1 to 2 per cent in 1800 to 20 per cent in 1914. In 1940, when

India was under colonial rule, restrictions on international trade and capital mobility were

imposed throughout the Sterling Area as wartime measures. India gained independence in

1947, but emphasized autarkic policies, with a marked closing of the economy in the

1960s and 1970s. By 1970, the trade/GDP ratio had dropped to 8 per cent.

By 1991, with experience and international comparisons for 44 years in hand, the

intellectual and policy consensus shifted against autarky. India then embarked on

reintegration into the world economy through trade and capital account liberalisation. By

the mid 1990s, the trade/GDP ratio had got back to the 20 per cent value seen in 1914. Page | 31

Reintegration into the world economy took place on both the current account and on the

capital account. The early initiatives in capital account decontrol werebased on three

ideas:

¤ It was believed that debt in inflows and all out ows were dangerous; hence strong

restrictions against debt in inflows and all out inflows were kept in place.

¤ It was believed that in inflows into the equity market were benecial, but only if they

originated from certain kinds of investors. Thus investment vehicles such as pension

funds and university endowment funds were considered good, while hedge funds and

individuals were considered bad. Hence, a limited opening was undertaken, where certain

kinds of `foreign institutional investors' (FIIs) were able to register in India with the

securities regulator, and then given substantial edibility including the lack of quantitative

restrictions.

While the official rhetoric was in favors of FDI, the removal of capital controls against

FDI was limited in many sectors. Deeper liberalization of capital controls against FDI

took place later.

This opening of the economy was a key element of India's growth acceleration of the

early 1990s. The combination of these reforms of the capital account, and trade

liberalisation, unleashed a complex dynamic of change in the economy and in economic

Policy. In this setting, the analysis of India's reintegration into the world economy is

usefully organized around the following key questions. What were the microeconomic

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and macroeconomic consequences of this partial opening? How did capital account and

current account opening interact with each other? What dynamic of change was

unleashed in the political economy through the map of interests of gainers and losers

associated with this mechanism of opening the economy? How did de facto openness

evolve in the following two decades? While the bulk of these questions remain

unanswered research puzzles, there is clarity on some sub-components of this larger

picture, which is sketched in the following sections

4.2 Internationalization of Firms

Firm internationalization lies at the centre of India's engagement with nancial

globalization. There is sharp evidence of internationalisation at the rm level. Five

dimensions of internalization can be examined:

1. A firm could import, thus buying raw materials and/or capital goods from foreign

providers;

2. A firm could export;

3. A firm could obtain equity capital from external sources;

4. A firm could obtain debt capital from external sources

(Whether local-currency denominated or foreign-currency denominated);

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5. A firm could expand overseas, thus placing foreign assets on its balance sheet.

In order to describe the extent of internationalization of Indian firms, we define four

categories: None 0 percent

Low Between 0 percent and 10 percent

Medium Between 10 percent and 50 percent

High Above 50 percent

Using information from the CMIE database, we classify all large Indian firms into one of

these four categories in all the four Dimensions.

Table 2 approaches internationalization of Indian firms by reporting the fraction of

aggregate firm size in each category. For our purposes, size is defined as the average of

firm sales and total assets. In 2001-02, 64 percent of total firms size involved

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corporations importing in the Medium or High categories. By 2008-09, this had risen to

66 per cent, a rise of 2 per cent. With exports, in 2001-02, 15 per cent of this mass was in

either Medium or High. By 2008-09, the total firm size with export intensity in the

Medium-High categories had risen to 20 per cent, a rise of 5 per cent. With both these

trade-based measures, the change in international economic integration over this period

was small. While the macroeconomic data on trade integration shows a sharp rise over

this period, this data for large firms does not show a sharp change.

Large changes are, however, visible across this period with measures of financial

internationalization. In 2001-02, 40 per cent of the mass of Indian firms had either

Medium or High equity investment. By 2008-09, this stood at 62 per cent: a sharp rise of

22 percentage points.

With foreign borrowing, in 2001-02, firms accounting for 39 per cent of the mass were in

either Medium or High categories. In 2008-09, this had risen to 54 per cent { despite the

stated policy of the government in aiming to deter debt in ows. Finally, with overseas

assets, less than 1 per cent of Indian firms had either Medium or High overseas assets in

2001-02. By 2008-09, the number of Indian firms with Medium or High overseas assets

had risen sharply to 6 per cent. Over half the mass of firms had non-zero outbound FDI.

A natural area of exploration lies in the interplay of internationalisation and financing

constraints. An early literature found that the domestic financial system, and particularly

the equity market, was sensitive to exporting status. Exporting firms faced reduced

financing constraints. However, this evidence is based on the early 1990s, while the large

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changes in internationalization of firm financing took place after 2000. These questions,

hence, lie largely unexplored.

4.3 Role of Foreign Direct Investment

India opened up slowly to FDI in the 1990s. The limits on the share of foreign ownership

was slowly increased in every sector. By 2000, while most sectors were open upto 100

percent, sectors where FDI was restricted include retail trading (except single brand

product retailing), atomic energy, and betting. Table 4 shows the areas where FDI caps

exist.

While inbound FDI investors have the ability to repatriate capital, so far, in the Indian

experience, this reverse flow of capital

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has been tiny. As an example, in 2006-07, it was 0.01% of GDP.

Hence, for all practical purposes, inbound FDI has been a one-way process of capital

coming into the country.

When compared with other emerging markets, India has attracted relatively little FDI.

The first phase of financial globalization primarily involved Indian firms obtaining equity

and debt capital from abroad, thus achieving a reduction in the cost of capital. This

bolstered the competitive position of Indian firms competing against foreign companies

producing in India through FDI and competing in global markets by exporting.

The easing of capital controls, coupled with strong investment opportunities in India,

gave a strong rise in FDI flows into India from 0.14% of GDP in 1992-93 to 0.53% in

1999-2000 and then to 2.34% of GDP in 2006-07

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From April 2000 to August 2007, $44 billion came into India through FDI. In terms of

the country composition, the bulk of

Country composition of FDI (April 2000 - August 2007)

FDI into India came in from Mauritius: the reason for this is that India has a preferential

tax treaty with Mauritius. Services, financial and non-financial, attracted the highest

amount of FDI. Between April 2000 to August 2007 USD 8 billion, or 20.6 percent of all

FDI flows, came into the services sector. Next was computer software and hardware

which attracted 16 percent of flows. Telecom (8.7%), automobile industry(8.7%) ,

construction (5.2%) and power (3.4%) came next. When FDI into India did rise

significantly from 2002 onwards, as much as two-thirds of this FDI took the form of

foreign private equity funds buying large stakes in Indian unlisted compa- nies. This

phenomenon can also be interpreted as foreign capital bolstering the competitive position

of Indian firms competing against foreign companies producing in India through FDI.

This experience can be located in the debates about `FDI as bad cholesterol' literature,

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where foreign portfolio investment is seen as a bigger accomplishment by an emerging

market. FDI requires little institutional capability, while foreign portfolio investment

requires high quality firms, domestic financial development, and capabilities in the legal

and regulatory system.

4.4 Foreign Portfolio Investment in the Equity Market

In the early 1990s, India opened investment into listed equities through the `FII

framework'. This involved the following key elements. Some, but not all, foreign

investors were eligible to register with the Indian securities regulator (SEBI). Once

registered, FIIs could buy shares in India without quantitative restrictions, or constraints

on repatriation. No one FII was permitted to own more than 5 per cent of a firm, and

there were weak restrictions on the ownership by all FIIs taken together.

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One response of global financial firms to the Indian FII framework has been the rise of a

market for `participatory notes which are OTC derivatives on Indian underlyings which

are traded offshore. A handful of global firms are book-runners on this market. A

foreigner who is not a registered FII with the Indian authorities is able to transact on the

PN market. The book-runners then hedge their net exposures of the book using the

onshore market, to which they have access by virtue of being registered FIIs in India.

One factor which has encouraged the use of PNs is the presence of transaction taxes on

the onshore market, while PN transactions avoid these.

As the home bias literature has emphasised, there are many sources of home bias, and

capital controls is only one element of these. In the event, when India embarked on a

limited easing of capital controls against equity inflows, the home bias of foreign

investors did not strongly change in response. Many other sources of home bias remained

in place, including asymmetric information, capability of the domestic financial system, a

limited number of listed firms of adequate size from the viewpoint of international

investors, etc.

The desire of policy makers to encourage foreign investors in the Indian equity market, in

the early 1990s, helped in reopening long-standing policy questions about the equity

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market. Foreign investors faced many difficulties in accomplishing transactions in the

Indian equity market. As an example, in August and September 1993, the settlement

system (which was based on physical paper share certicates) found it difficult to handle

the settlement volume of foreign investors. Similarly, foreign investors who sent orders to

the open outcry trading floor of the Bombay Stock Exchange found an array of problems

including high transactions costs and low probability of order execution.

A first response of many Indian firms was to issue in New York or London through

GDRs and ADRs, thus using the institutional capability of these financial systems, and

bypassing the infirmities of the domestic financial system. In the early 1990s, there was a

sharp increase in this issuance.

When faced with similar conditions, many other developing countries have experienced a

hollowing out of domestic financial intermediation. When a weak domestic financial

system is difficult to reform for political reasons, domestic firms tend to interact with

foreign investors in international financial centers like New York or London, leading to a

shift in financial intermediation to offshore venues.

In the Indian case, from 1993 to 2001, the Ministry of Finance and SEBI led a strong

reforms effort aiming at a fundamental transformation of the equity market. The changes

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on the equity market from December 1993 to June 2001 helped to increase liquidity,

reduce risk, improve disclosure and increase the number of investors and trades in the

market. These reforms led to a shift in the focus of foreign investors away from Indian

securities traded in London or New York, and the primary markets for India-related

equities trading became the NSE and BSE in Bombay.

These changes addressed one important source of home bias the deficiencies of financial

development in emerging markets and were associated with a decline in home bias by

foreign investors against investing in India. In 1991, the weight of Indian equities in the

portfolio of international investors was zero. In the first decade of India's opening, this

share rose to only 0.04 per cent, reacting a largely unchanged extent of home bias against

India. By 2007, there was a six-fold rise in this weight to 0.24 per cent, suggesting an

easing (though not elimination) of home bias.While India obtained significant financial

development and capital account decontrol on the equity market, neither of these changes

took place with the bond market and banks. In the same period, firms undertook strong

deleveraging through emphasis on equity financing: the debt-equity ratio of large non-

financial firms dropped sharply from 1.7 in 1991 to 0.7 in 2007. There may be a causal

relationship here: when firms faced greater financing constraints on bond- or bank-

financing alongside reduced financing constraints for equity financing, they may have Page | 42

shifted in favour of greater equity financing. Consequently, while the share of foreign

investors in equity rose sharply, in the bond markets it remained limited. Further there

were regulatory caps on the stock of holdings of government bond by foreign investors.

Corporate bonds were allowed to be held by foreign institutional investors only after

2004.

4.4 Foreign Borrowings

In the international literature and in policy thinking amongst emerging markets, the

question of currency exposure has come to prominence. When the exchange rate regime

gives out expectations of low currency risk, firms and governments are encouraged to

borrow in foreign currency. Once currency mismatches are present, when large

depreciations take place, this generates considerable distress.

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Indian capital controls have been biased against foreign borrowing and particularly

against short-dated foreign borrowing. This policy framework does not reflect an

appreciation of issues of currency exposure. Strong restrictions are in place against FII

investment in rupee-denominated bonds, while a much larger scale of offshore borrowing

in foreign currency takes place. This policy framework has encouraged unhedged

currency by firms, particularly in periods when the exchange rate regime involved greater

pegging.

These issues came to prominence in 2008, when exchange rate volatility rose, a sharp

depreciation took place, and the global credit market experienced turbulence. This had an

adverse impact on the balance sheets of many Indian firms, particularly those which had

borrowed abroad. The experiences of this period emphasized the weaknesses of India's

policy positions on the three issues of original sin, the lack of development of the

domestic bond market and the lack of development of a domestic banking system.

CHAPTER 5

5.1 Conclusion

The implications of globalization for a national economy are many. Globalization has

intensified interdependence and competition between economies in the world market.

This is reflected in Interdependence in regard to trading in goods and services and in

movement of capital. As a result domestic economic developments are not determined

entirely by domestic policies and market conditions. Rather, they are influenced by both

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domestic and international policies and economic conditions. It is thus clear that a

globalising economy, while formulating and evaluating its domestic policy cannot afford

to ignore the possible actions and reactions of policies and developments in the rest of the

world. This constrained the policy option available to the government which implies loss

of policy autonomy to some extent, in decision-making at the national level.

CHAPTER 6

6.1Bibliography

Books and Periodicals:

Financial Market In India…………… S. Parveen

Financial Markets…………….. Gorden Natrajan

Websites: http://www.webcrawler.com/info.wbcrwl.305.03/search/web?

q=role+of+financial+markets&cid

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http://www.investopedia.com/walkthrough/corporate-finance/1/financial- markets.aspx

http://en.wikipedia.org/wiki/Financial_services

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