CHAPTER 11
Policy Issues
This chapter reviews the strengths and weaknesses of Indian finance and
sketches the directions for reform.
11.1 THE STATE OF INDIAN FINANCE
The outstanding success story of Indian finance is the equity market, which has
achieved a full ecosystem with high levels of liquidity and market efficiency.
It has:
Private equity investors;
The IPO market;
A fairly liquid secondary market, with electronic trading, competing
exchanges, nationwide anonymous electronic trading, risk management
at the clearing corporation;
Derivatives trading;
Mutual funds;
Stock market indexes, index funds and index derivatives;
Barring barriers faced by pension funds, few domestic participants are
blocked from market access;
Participation from overseas players through the FII framework, accentu-
ated using participatory notes.
All these features have been described in various chapters of this book. While
the government is involved in regulation and supervision of the equity market,
it has no role in determining prices of equity securities.
1
In contrast, with the
three other elements of finance, namely currencies, commodities and bonds,
1
For a treatment of the policy debates and evolution of the equity market, see Shah and Thomas
(2000) and Echeverri-Gent (2007).
191
192 India’s Financial Markets
speculative price discovery does not take place in India. The government is
deeply involved in determining prices.
Figure 11.1, drawn from Mistry (2007), shows the Bond-Currency-
Derivatives Nexus as it operates in a mature market economy. In an Indian
setting, the BCD Nexus would involve the rupee riskless yield curve, with
issuance and investment from all over the world of riskless rupee denominated
government bonds. There would be rupee credit curves, also with issuance and
investors from all over the world. The fixed-income markets would interface
with global yield curves through the currency spot and derivatives markets.
Alongside this would be the credit derivatives market, which would (in turn)
be linked with the equity market through arbitrage.
Currency spot & derivatives
Foreign firms
issuin
g
bonds
Global traders
on currenc
y
markets
Global government
bond investors
Global credit
risk investors
Rupee
Riskless
Curve
USD
Yield
Curve
Euro
Yield
Curve
Yen
Yield
Curve
Credit spot
& derivatives
Rupee
Credit
Curves
Interest rate spot & derivatives
Foreign governments
issuing bonds
FIGURE 11.1 The Bond-Currency-Derivatives Nexus

Get Indian Financial Markets now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.