global financial crises and indian capital market: an ...

I J A B E R, Vol. 10, No. 1, (2012): 11-29

GLOBAL FINANCIAL CRISES AND INDIAN CAPITAL MARKET: AN ECONOMETRIC ANALYSIS P. K. Mishra*

Abstract: In recent years, the World Economy has been experiencing a critical phase in terms of decline in gross national products, rise in unemployment levels, and slump in investment activities. Such global scenario has affected the global growth and welfare. The epicentre of these problems is the economic and financial crises of west. The crises originated from deceptively small sources of west - sub-prime lending in the US in 2008 and government debt in Greece in 2011. But, these crises have wobbled the backbone of the world economy. India being relatively integrated with and open to the global economy has been affected by these crises. Currently, the national economy is passing through a phase of high inflation, exchange rate crisis, volatile capital market, discouraging investment scenario and increase in fiscal deficits. India has witnessed massive withdrawal of FII investments and subsequent crash of the capital market due to global crisis. Since capital market segment has been affected much by the global crises, this study is an attempt to examine the performance of the Indian capital market in terms of market size, market liquidity, market turnover, market volatility, and market efficiency over the period 2008 to 2011. Although the capital market of India showed relatively greater degree of volatility and weak form inefficiency during crises, the study found the evidence of the potential for increase in market size, more liquidity and reasonable market turnover. Therefore, the planners, policy makers and regulators should devise prudential norms and implement fair market practices to make the national economy more resilient to cross border contagions. Keywords: India, Capital Market, Performance Analysis, US crisis, Eurozone Crisis JEL Classification Code: C10, C13, C51, G10, G14

I.

INTRODUCTION

The beginning of 21st century can best be described as the period of economic and financial uncertainty. This period witnessed the first crisis with the burst of dot com bubble in 2000 followed by US sub-prime crisis in 2007-08 and most recently the European debt crisis in 2011. After the dot com bubble burst in the US, monetary policy in US and other advanced economies was substantially eased. Policy rates in the US reached one per cent in June 2003 and were held constant around that levels for an extended period up to June 2004. In the subsequent period, the withdrawal of monetary accommodation was quite gradual. An empirical assessment of the US monetary policy indicates that the actual policy during the period 2002-06, especially during 2002-04, was substantially looser than what a simple Taylor rule would have required. This was an unusually big deviation from *

Assistant Professor of Economics, Siksha O Anusandhan University, Bhubaneswar, Odisha, India, E-mail: [email protected]

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P. K. Mishra

the Taylor Rule1. In the post dot com period excessively loose monetary policy boosted consumption and investment in the US. With such low nominal and real interest rates, asset prices recorded strong gains, particularly in housing and real estate, which provided further impetus to consumption and investment through wealth effects. Thus, aggregate demand consistently exceeded domestic output in the US and, given the macroeconomic identity, this was mirrored in large and growing current account deficits in the US over the period. The large domestic demand of the US was met by the rest of the world, especially China and other East Asian economies, which provided goods and services at relatively low costs leading to growing surpluses in these countries. Sustained current account surpluses in some of these Emerging Market Economies (EMEs) also reflected the lessons learnt from the Asian financial crisis. Furthermore, the availability of relatively cheaper goods and services from China and other EMEs helped to maintain price stability in the US and elsewhere, which might have not been possible otherwise. Thus, inflation rates in the advanced economies remained low which contributed to the persistence of accommodative monetary policy. On account of this accommodative monetary policy dysfunctional global imbalances emerged in the post 2000 phenomenon. Apart from creating large global imbalances, accommodative monetary policy and the existence of very low interest rates for an extended period encouraged the search for yield, and relaxation of lending standards. The sustained rise in asset prices, particularly house prices, on the back of excessively accommodative monetary policy and lax lending standards during 2002-2006 coupled with financial innovations resulted in a large rise in mortgage credit to households, particularly low credit quality households. Most of these loans were with low margin money and with initial low teaser payments. Due to the “originate and distribute2” model, most of these mortgages had been securitized. In combination with strong growth in complex credit derivatives and the use of credit ratings, the mortgages, inherently sub-prime, were bundled into a variety of tranches, including AAA tranches, and sold to a range of financial investors of not only in USA, but also to the investors of Europe and Asia. Financial innovations, regulatory arbitrage, lending malpractices, excessive use of the originate and distribute model, securitisation of sub-prime loans and their bundling into AAA tranches on the back of ratings, all combined to result in the observed excessive leverage of financial institutions. The excessive leverage on the part of banks and the financial institutions (among themselves), the opacity of these transactions, the mounting losses and the dwindling net worth of major banks and financial institutions led to a breakdown of trust among banks. Given the growing financial globalization, banks and financial institutions in other major advanced economies, especially Europe, have also been adversely affected by losses and capital write-offs. Inter-bank money markets nearly froze and this was reflected in very high spreads in money markets.

Global Financial Crises and Indian Capital Market: An Econometric Analysis

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As Europe was hit by the financial crisis of USA, many countries faced increasing welfare spending. Ireland and Spain needed money to save their banks from bankruptcy. Unemployment was on the rise. And, the real estate boom, which had traversed to these countries as well, found it the suitable time to go bust. Tax receipts thus collapsed. And, then Germany made the mistake of asking the bond holders to share a part of the losses if the Government defaults. This spawned fear among the investors that European bonds were no safer. Investors started pulling out. This set off crashing bond prices, weakening banks and slowing growths. The European countries like Greece and Italy, which were earlier considered unreliable and having large current account deficits, got the chance of borrowing large amounts of money due to powerful Euro and lower interest rates and used it for public spending prior to global financial crisis of 2008. But with the financial crisis of 2008, the inflows became less and so did the tax receipts and Greece was left with a staggering amount of public debt. Then it went into the Debt crisis of 2011. Thus, excessively accommodative monetary policy for an extended period in the major advanced economies in the post dot.com crash period sowed the seeds of the global financial crisis of 2008 and European debt crisis of 2011. In the context of these financial and economic crises, Indian economy can be looked to be relatively insulated. The global financial crisis got transmitted to India in January 2008 with the beginning of a massive withdrawal of FII investments from Indian capital market that ultimately responsible for the capital market crash in India. Since in the aftermath of global financial crisis, capital market crash was the primary impact on India, it is imperative to examine the performance of Indian capital market in the post crisis period. Furthermore, it is quite essential to make an investigation of the impact of most recent Euro-zone debt crisis on the capital market of India. It is with this backdrop, this paper is an attempt to examine the performance of India’s capital market in the crises and post crises period. The rest of the paper is organised as follows: Section II is an overview of India’s capital market; Section III is the review of related studies; Section IV is the discussion of data and methodology of the study; Section V makes the analysis and discusses the findings; and Section VI concludes. II. OVERVIEW OF INDIA’S CAPITAL MARKET

Indian Capital market has witnessed a paradigm shift at par with the advanced markets of the world in the last two decades or so. Business process, functionality, monitoring/ regulating mechanisms, hardware, software etc., are all revamped to compete with the global leaders. The current stand of Indian capital market has a long history in its back. The history of the capital market in India dates back to the eighteenth century when East India Company securities were traded in the country. In 1850s, the trading was limited to a dozen brokers and their trading place was

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under a banyan tree in front of the Town Hall in Bombay. The location of trading changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as ‘The Native Share & Stock Brokers Association’. In 1895, this association acquired a premise in the Dalal Street and it was inaugurated in 1899. Thus, the Stock exchange at Bombay was consolidated. And, the orderly growth of the capital market in India began. The Bombay stock exchange got recognition in May 1927 under the Bombay Securities Contracts Control Act, 1925. The constitution of India came into being on 26th January, 1950. The constitution put the stock exchanges and the forward markets under the exclusive authority of the Government of India. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the Securities Contracts (Regulation) Act. The 1980s witnessed an explosive growth of the securities market in India, with millions of investors suddenly discovering lucrative opportunities. Many investors jumped into the stock markets for the first time. The government’s liberalization process initiated during the mid-1980s, spurred this growth. The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a means to measure overall performance of the exchange. The 1990s will go down as the most important decade in the history of the capital market of India. The Capital Issues (Control) Act, 1947 was repealed in May 1992. The decade was characterized by a new industrial policy, emergence of SEBI as a regulator of capital market, advent of foreign institutional investors, euroissues, free pricing, new trading practices, new stock exchanges, entry of new players such as private sector mutual funds and private sector banks, and primary market boom and bust. The 1991-92 securities scam revealed the inadequacies of and inefficiencies in the financial system. It was the scam, which prompted a reform of the equity market. The Indian stock market witnessed a sea change in terms of technology and market prices. Technology brought radical changes in the trading mechanism. The Bombay Stock Exchange (BSE) was subject to nationwide competition by two new stock exchanges – the National Stock Exchange (NSE), set up in 1994, and Over the Counter Exchange of India (OTCEI), set up in 1992. The National Securities Clearing Corporation (NSCC) and National Securities Depository Limited (NSDL) were set up in April 1995 and November 1996 respectively form improved clearing and settlement and dematerialized trading. The Securities Contracts (Regulation) Act, 1956 was amended in 1995-96 for introduction of options trading. Moreover, rolling settlement was introduced in January 1998 for the dematerialized segment of all companies. With automation and geographical spread, stock market participation increased. In 1996, the National Stock Exchange of India launched S&P CNX Nifty and CNX Junior Indices that make up 100 most liquid stocks in India. CNX Nifty is a diversified index of 50 stocks from 25 different economy sectors. The Indices are owned and managed by India Index Services and Products Ltd (IISPL) that has a consulting and licensing agreement with Standard & Poor’s. In 1998, the National Stock Exchange of India


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launched its web-site and was the first exchange in India that started trading stock on the Internet in 2000. The NSE has also proved its leadership in the Indian financial market by gaining many awards such as ‘Best IT Usage Award’ by Computer Society in India (in 1996 and 1997) and CHIP Web Award by CHIP magazine (1999). In 2000 the BSE used the sensitive index, i.e., Sensex to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE’s trading platform. The introduction of rolling settlement system in all scrips and electronic fund transfer in 2003 reduced the settlement cycle to T+2. During the bull rally (2003-2007) there was considerable exuberance. This was the time when interest rates were low. Credit was available and that too cheaply. Not just that, corporate profits were growing at a healthy rate. Stock markets were notching strong gains. Indian capital market in 2007-08, thus, features a developed regulatory environment, a modern market infrastructure, a steadily increasing market capitalization and liquidity, better allocation and mobilization of resources, a rapidly developing derivatives market, a robust mutual fund industry, and increased issuer transparency. But the global credit crisis of 2008-09 changed all that. The abundant liquidity, not surprisingly, led to asset bubbles that finally burst. Indian capital market has seen its worst time with the global financial crisis. The most popular stock index, i.e., Sensex declined to its levels attained in December 2005. Similar decline has also been noticed for S & P CNX Nifty index. With the volatility in portfolio flows having been large during 2007 and 2008, the impact of global financial turmoil has been felt particularly in the equity market. Indian stock prices have been severely affected by foreign institutional investors’ (FIIs’) withdrawals. FIIs had invested over Rs 10,00,000 crore between January 2006 and January 2008, driving the Sensex 20,000 over the period. But from January, 2008 to January, 2009, FIIs pulled out from the equity market partly as a flight to safety and partly to meet their redemption obligations at home. These withdrawals drove the Sensex down from over 20,000 to less than 9,000 in a year. It has seriously crippled the liquidity in the stock market. The stock prices have tanked to more than 70 per cent from their peaks in January 2008 and some have even lost to around 90 per cent of their value. This has left with no safe haven for the investors both retail and institutional. The primary market got derailed and secondary market was in the deep abyss. Equity values were at very low levels and many established companies were unable to complete their rights issues even after fixing offer prices below related market quotations at the time of announcement. Subsequently, market rates went down below issue prices and shareholders were considering purchases from the cheaper open market or deferring fresh investments. This situation naturally had upset the plans of corporate houses to raise resources in various forms for their ambitious projects involving heavy outlays.

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Despite the scale down of popular capital market indices up to the first quarter of 2009, Indian stock markets then provide the evidence of strong resistance to global financial contagion. The year 2009-10 saw an upsurge in turnover on the exchanges, mainly on account of recovery of the global financial markets. The turnover on the NSE rose by 50.36% in 2009-10 compared with 2008-09 and that on the BSE it increased by 25.34% over the same period. The average daily turnover on the NSE stood at US $ 3.5 billion in 2009-10 compared to US $ 2.0 billion in 200809. Though the average daily turnover on the BSE rose to US $ 1.1 billion in 2009-10 from 0.89 billion in the previous year, it is still below the average daily turnover of US $ 1.6 billion recorded in 2007-08. As the trends in turnover showed a jump in 2009-10 compared to 2008-09, the same was the case with market capitalization for securities available for trading on the equity segment of NSE and BSE. After witnessing enormous growth during 2007-08 in comparison to 2006-07, 2008-09 saw a fall in market capitalization followed by jump in 2009-10 over 2008-09 levels. The market capitalization of NSE, which as at end March 2008 amounted to INR 48,581,217 million (US $ 1,215 billion), were down to INR 28,961,940 million (US $ 568 billion) on the NSE as at end March 2009. As at end September 2010, there has been some increase in market capitalization to US $ 1,549 billion from US $ 1,255 billion for NSE as at end of March 2010. This infers the strong investor confidence and well risks diversification in Indian capital markets. In 2009 the market was in a recovery mode; in 2010 it consolidated. The fundamentals were strong. With average 8.9% growth in the first three quarters of 2010 the economy is well poised to rush into 2011 with good performance. By this time, consumer demand was strong, exports were rising and investment was building up. In 2010 stock prices increased 25% almost all the rise being in the second half of the year though corporate performance was better in the first half. The difference was the investment by FIIs to which the market is extremely sensitive. The RBI has estimated that a 10% fluctuation in FII investment results in a 35% variation in stock prices. In the first half of 2010 FII net investment was a mere Rs. 300 billion; in the second five months it rose to Rs. 1010 billion. The year 2010-11 has been another record year for the Indian capital markets with 124 IPOs (Initial Public Offerings) and FPOs (Follow on Public Offerings) and 41 QIPs (Qualified Institutional Placements). According to Bloomberg data, proceeds from fresh issues (IPOs) by Indian companies in 2010 surpassed even the levels reached in 2007. The Government made a strong mark on the markets, raising significant capital with string of IPOs and FPOs. Till March 2011, 124 IPOs had accounted for Rs. 51,000 crore (US$11.3 billion) in capital raised, averaging close to a billion dollar every month. This along with 41 QIPs that raised nearly Rs. 19,722 crore (US$4.3 billion) meant that Indian companies rose more than Rs. 70,000 crore (US$15.5 billion) in the 2010-11 financial year. It is, therefore, evident that the India’s capital market has shown good resilience and quick recovery from the global financial meltdown. In this context, it is essential


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that an empirical study be performed to examine the performance of the capital market of India. Performance of Indian Securities Market during 2000-2010 It can be seen that during the decade, there has been a significant rise in the market capitalization ratio, turnover ratio and traded value ratio. The turnover in the cash market has nearly doubled over the decade while the market capitalization has become eight times the levels that existed in 2000. Figure 1: All India Market Capitalization Ratio and Turnover Ratio

The turnover in the Indian derivatives market has increased from US $ 0.086 trillion in 2000-01 to US $ 3.92 trillion in 2009-10 and has surpassed the cash market turnover in India. The resource mobilization in the primary market has increased dramatically, rising six fold between 2000 and 2010. Similarly, the resource mobilization through euro issues has increased significantly over the years. The performance of the Indian capital market has been impressive with high returns and a high level of investment from both domestic and foreign investors. III. RELATED STUDIES

There has been a wide range of studies performed in the financial economics literature concerning the Indian capital market. Several studies such as Sahni (1985), Kothari (1986), Mookerjee (1988), Lal (1990), Ramesh Gupta (1991,1992), Raghunathan (1991), Gupta (1992), and Sinha (1993) comment upon the Indian capital market in general and trading systems in the stock exchanges in particular. Raju and Ghosh (2004) empirically observe that emerging capital markets exhibit higher intra-day volatility compared to developed markets. It is a sign of an emerging market owing to economic and socio-political variations; the volatility in

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Figure 2: Growth in All India Equity Market Turnover and Market Capitalization (USD mn)

Figure 3: Resource Mobilization in Primary Market (USD mn)

Figure 4: Resource Mobilization through Euro Issues (USD mn)


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Figure 5: Net Investment by FIIs and Mutual Funds in USD mn)

Figure 6: Equity Derivatives Turnover (USD mn)

the emerging markets is generally on the high side. Chakrabarti and Mohanty (2005) discuss how capital market in India is evolved in the reform period. Bajpai (2006) concludes that the capital market in India has gone through various stages of liberalisation, bringing about fundamental and structural changes in the market design and operation, resulting in broader investment choices, drastic reduction in transaction costs, and efficiency, transparency and safety as also increased integration with the global markets. The opening up of the economy for investment and trade, the dismantling of administered interest and exchange rates regimes and setting up of sound regulatory institutions have enabled time. Mishra

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et al. (2010) studied the performance of Indian capital market for the period 2002 to 2009 and provides the evidence of greater volatility and weak form inefficiency of the market. The market also shows strong potential for greater market size, more liquidity and reasonable market turnover ratio. Mishra and Pradhan (2009) studied the efficient market hypothesis in the context of Indian equity market for the period 2001 to 2009 and provided the evidence of weak form inefficiency of Indian capital market over the sample period. Prasad and Reddy (2009) examined the impact of global financial crisis on India and observed that the combination of a rapid sell off by financial institutions and the prospect of economic slowdown have pulled down the stocks and commodities market in India. Suresh (2010) studied the impact of financial crisis on Indian capital market in arena of financial innovations and concluded that financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking and financial markets from becoming extremely volatile and turbulent which boosted investors confidence. Mall and Mishra (2012) attempted to make a post-mortem of the crises of west and impacts on Indian economy. The study suggested that there should be effective supervision of all financial activities, both private and public, if the country is to be crisis resilient. Karmakar and Mishra (2012) provided a comprehensive picture of global financial and economic crises and their impacts on India. Sahoo and Sethi (2012) examined the impact of current global financial crisis on Indian economy and found that in comparison to the advanced capitalist countries of the west, India has not much affected by this crisis. This literature review brings into forefront the fact that the capital market literature lacks the empirical study of the performance of the Indian capital market, especially in the aftermath of global financial crisis. Therefore, in this paper an attempt has been made to study empirically the performance of Indian capital market and enrich the literature in this direction. IV. DATA AND METHODOLOGY

Indian capital market is truly an emerging market as it is significant in terms of the degree of development, volumes of trading and in terms of its tremendous growth potential. Thus, this study uses the parameters like market size, market liquidity, market turnover, market volatility, and market efficiency to gauge the performance of Indian capital market. This paper assumes the two leading stock exchanges of India, namely, Stock Exchange, Mumbai and National Stock Exchange, India as the proxies for Indian capital market. All the relevant data have been gathered from the publications of RBI, NSE India, and SEBI and from the websites of BSE India, NSE India, RBI, and SEBI. The sample period of the study spans from January 2002 to December 2011. The study uses the techniques of trend analysis to analyse the growth pattern of India’s capital market in terms of market size, liquidity, and turnover over the sample period.


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The study further uses the Threshold GARCH (1,1) model to capture the time varying volatility of India’s capital market. The volatility modelling uses daily stock returns data based on closing Sensex for BSE and Nifty for NSE over the sample period from Jan 2008 to December 2011. This period is significant to include the sub-prime crisis of US and Debt crisis of Euro zone. The performance of BSE Sensex and S & P CNX Nifty can be observed for the sample period from Fig. 7. Figure 1: Movements in BSE Sensex and NSE Nifty (From Jan 2008 to Dec 2011)

It is inferred that the stock price indices in India’s equity market shows a downturn till the first quarter of 2009 due to the impact of Global Financial crisis that originated from US sub-prime crisis in 2008. However, Indian capital market showed an incredible resilient and recovered from the beginning of FY 2009. The bull rally continues till December 2010. Thereafter, the indices witnessed larger volatility and bearish trend, particularly due to the activities of FIIs and panic of Euro Zone crisis of 2011. This is the reason why we have selected this sample period for analysing the performance of India’s capital market. First, the daily stock returns (Rt) are calculated by the log difference change in

 Pt  the price index: Rt = log  P  where Rt is the daily stock return at time ‘t’ and Pt  t −1  and Pt–1 are the closing value of the stock price Indices at time ‘t’ and ‘t–1’ respectively. Then, the Threshold GARCH (1,1) model has been estimated to investigate whether good or bad news contributes to the volatility of Indian capital market. The specification for conditional variance (volatility) in Threshold GRACH (1, 1) model is:

σt2 = ω + (α + γRt −1 )εt2−1 + βσt2−1

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Here, the dummy variable It–1 is an indicator for negative innovations and is defined by: It–1 = 1, if εt–1 < 0 and It–1 = o if εt–1 ≥ 0. In this model, good news, εt–1 > 0, and bad news, εt–1 < 0, have differential effects on the conditional variance; good news has an impact of α, while bad news has an impact of α + γ. If γ > 0, then bad news increases volatility, and we say that there is a leverage effect. If γ ≠ 0, the news impact is asymmetric. The study also examines the weak form efficiency of India’s capital market to observe the effectiveness of the information flow. In this study, the non-parametric test as suggested by Phillips and Perron (1988) is performed to examine the informational efficiency of Indian capital market. The Phillips and Perron (PP) method estimates the following equation: ∆Rt = αRt −1 + xt' δ + εt & α = ρ – 1 Where, Rt is the quarterly Sensex based stock market return, xt are optional exogenous regressors which may consist of constant, or a constant and trend, ρ are δ parameters to be estimated, and, εt are assumed to be white noise. The null and alternative hypotheses of this test are H0 : α = 0 (existence of unit root or nonstationarity) vs. H1 : α < 0 V. EMPIRICAL ANALYSIS AND DISCUSSION

This paper embarks upon the empirical study of the performance of Indian capital market taking into account the analysis of the parameters like market size, market liquidity, market turnover, market volatility, and market efficiency over the sample period of 2002-11 by examining the annual, and the daily data. (A) Market Size The size of a capital market as measured by stock market capitalization is positively correlated with the ability to mobilise capital and diversify risk on an economywide basis. The size of the Indian capital market can be assessed by employing the stock market capitalisation to GDP ratio Levine and Zervos (1998). This size ratio of Indian capital market is shown in Table 1. Table 1 Market Size (BSE and NSE) Year 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Size Ratio (BSE) %

Size Ratio (NSE) %

23.31 43.60 53.92 84.41 85.50 109.00 139.44 131.59 136.86

21.88 40.69 50.34 78.57 81.22 103.07 130.21 125.59 133.47


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It has been observed that the market size of Indian capital market is increasing over the years except in 2009-10. This year’s decline in market size is the effect of global financial crisis on Indian capital market. Thus, the overall indication is that in India the size of capital market is expanding which is the signal for strong potential of the market to mobilise capital for the economic development of the country. (B) Market Liquidity Market Liquidity refers to the ability to buy and sell securities easily. Liquid capital market allows companies on the one hand, to have a permanent access to capital through equity issues and on the other hand, to allow investors to switch out of equity if they need to access funds or if they want to change the composition of their portfolios. The market liquidity is measured by the ratio of total value of shares traded to GDP. The liquidity ratio in Indian capital market is shown in Table 2. Table 2 Market Liquidity (BSE and NSE) Year 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Liquidity Ratio (BSE) %

Liquidity Ratio (NSE) %

14.16 20.91 19.93 28.71 30.67 46.45 33.43 39.92 23.10

27.87 45.76 43.82 55.22 62.40 104.48 83.64 119.83 74.79

The above table infers that the market liquidity of Indian capital market is somewhat less during 2008-09 and 2010-11. This is reflection of the impact of global slowdown on Indian capital market. However, the overall performance of the ratio indicates that the Indian capital market is liquid and in particular the liquidity of NSE India is quite higher than that of Stock Exchange, Mumbai. The ratio performance of 2009-10 and 2010-11 is also appreciable for the National stock Exchange. (C) Market Turnover The market turnover gives the total value of shares traded in relation to the size of the market. It is the most important indicator of market activity. It is calculated as the ratio of total value of shares traded to the market capitalisation. The turnover ratio is also the indication of market liquidity. This ratio for Indian capital market is shown in Table 3.

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P. K. Mishra Table 3 Market Turnover (BSE and NSE)

Year 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Turnover Ratio (BSE) %

Turnover Ratio (NSE) %

54.88 41.84 30.54 27.00 26.97 30.72 23.97 30.34 16.88

115.05 98.08 71.90 55.79 57.76 73.09 64.23 95.41 56.03

It is very clear from the Table 3 that the turnover ratio in Indian capital market is oscillatory. Particularly, the performance of the ratio in BSE is disappointing. The low levels of turnover ratio in BSE can be interpreted as the low levels of trading activities in comparison to NSE. High turnover ratio of NSE may be due to its transparency, technological sophistication, and after all may be due to the efficient payment and settlement framework. (D) Market Volatility Market volatility is the degree to which asset prices tend to fluctuate. Volatility is the variability or randomness of asset prices. Volatility is often described as the rate and magnitude of changes in prices and in finance often referred to as risk. This research focuses particularly on time series volatility behaviour in Indian capital market during January 2008 to December 2011. The objective is, thus, to investigate the volatility characteristics of the Indian capital market measured by fat tail, volatility clustering, and leverage effects. The descriptive statistics pertinent to the return series so defined for Indian capital market are summarized in Table-4. Table 4 Descriptive Statistics of Return series Statistics Mean Standard Deviation Skewness Kurtosis Jarque-Bera Statistic

BSE

NSE

-0.000277 0.019876 0.294216>0 9.563975>3 1777.094 with probability zero

-0.000294 0.019899 0.165514>0 10.80170>3 2451.747 with probability zero

The measure of kurtosis suggests that the daily stock return series in Indian capital market have fatter tails than the normal distribution over the sample period. That is, the probability of extreme returns that has been observed empirically is higher than the probability of extreme returns under the normal distribution. This


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is termed as Lepto-kurtosis, or simply ‘fat tails’. The daily stock returns series are, thus, not normally distributed – a conclusion which is confirmed by the JarqueBera (JB) test. The existence of fat tails indicates the time varying volatility of the Indian capital market. Now to test the volatility clustering in Indian capital market, the daily stock return series based on closing values of Sensex and S & P CNX Nifty over the sample period have been plotted as shown in Figure 7. It is apparent in the figure that the amplitude of daily stock returns is changing in Indian capital market. The magnitude of this change is sometimes large and sometimes small. This sort of effect is called volatility clustering. And, this volatility is higher when stock prices are falling than when prices are rising. It means that the negative returns are more likely to be associated with greater volatility than positive returns. This is called asymmetric volatility effect. It is also evident that the volatility was relatively more during July 2008 to March 2009, and then volatility is substantially less till December 2010. The year 2011 shows greater degrees of volatility but not as evidenced till March 2009. The greater degree of volatility during July 2008 to March 2009 was due to global financial meltdown, and the relatively smaller degree of volatility in 2011 may be due to FII activities and the threat of euro area crisis. This indicates relatively lesser impact of 2011 economic crisis on Indian stock markets than that of the 2009 global financial crisis. Figure 7: Movements in BSE Sensex and NSE Nifty Based Daily Returns (From Jan 2008 to December 2011)

But to concretely draw any inference about the event whether good news or bad news that increases volatility in Indian capital market, the regression based on Threshold GRACH(1,1) model has been estimated for the said sample period. The results are reported in Table 5 & 6.

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P. K. Mishra Table 5 T-GARCH (1, 1) Estimates of Daily Stock Returns based on Sensex Coefficient

ω α γ β

3.01E-06 0.048443 0.132748 0.885906

Std. Error

z-Statistic

Prob.

1.11E-06 0.011524 0.024846 0.014765

2.719807 4.203579 5.342792 59.99881

0.0065 0.0000 0.0000 0.0000

It shows that the good news has an impact of 0.048443 magnitudes and the bad news has an impact of 0.048443+0.132748 = 0.181191 magnitudes in the Stock exchange, Mumbai. Table 6 T-GARCH (1, 1) Estimates of Daily Stock Returns based on CNX Nifty Coefficient ω α γ β

9.37E-06 0.047171 0.159716 0.858543

Std. Error

z-Statistic

Prob.

1.52E-06 0.014299 0.027845 0.018242

6.165392 3.298883 5.735838 47.06526

0.0000 0.0010 0.0000 0.0000

It shows that the good news has an impact of 0.047171magnitudes and the bad news has an impact of 0.047171+0.159716= 0.206887 magnitudes in the National Stock exchange of India. Thus, it is inferred that in the Indian capital market, the bad news increases the volatility substantially. Also, this time varying stock return volatility is asymmetric. The change in the pattern of volatility and the recent irregular behaviour of the stock market came as a result of the global economic events, particularly the global financial crisis of 2008 and most recent Euro area economic crisis. This study shows that crises have created an unprecedented high level of volatility during 2008-09 and could explain to some degree the recent sluggish performance of the market. (E) Market Efficiency The term ‘market efficiency’ is used to explain the relationship between information and share prices in the capital market literature (Mishra, 2009) and Mishra et al, 2009). An efficient capital market is commonly thought of as market in which security prices fully reflect all relevant information that is available about the fundamental value of the securities. Fama (1970) defines an efficient market as a market in which prices always reflect the recent available information and states that three different levels of efficiency exist based on what is meant as ‘available information’ – the weak, semi-strong, and strong forms. Weak form efficiency exists when security prices reflect all the information contained in the history of past prices and returns. If


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capital markets are weak-form efficient, then investors can not earn super-normal profits (excess profits) from trading strategies based on past prices or returns. Therefore, stock returns are not predictable, and hence follow a random walk. Under semi-strong form efficiency, security prices reflect all publicly available information. Investors, who base all their decisions on the information that becomes public, cannot gain above-average returns. Under strong form efficiency, all information - even apparent company secrets – is incorporated in security prices and thus, no investor can earn excess profit by trading on public or non-public information. The objective of this part of the study is testing the weak form efficiency in Indian capital market. And, we used the most popular unit root test to cater the need. In the class of unit root test, the Phillips-Perron Test is considered most powerful to examine whether Indian capital market is efficient in its weak-form or not. The results of this test for a sample period from January 2008 to December 2011 as applicable to BSE and NSE are summarized in Table 7. Table 7 Results of Phillips-Perron Unit Root Test Indian capital Market

PP Unit Root Test Statistic with Intercept

Stock Exchange, Mumbai National stock Exchange

-29.03488 < -3.436796 at 1% level with Prob.=0 -29.41640 < -3.436796 at 1% level with Prob.=0

Clearly, the null hypothesis of unit root in the series of index based daily returns is rejected in the capital market of India at 1% level of significance. Thus, Indian capital market is not efficient in its weak form. This market inefficiency is an indicative of sub-optimal allocation of portfolios into capital market of India. From the perspective of investors, the weak form inefficiency can provide an opportunity for earning supernormal profits. V. CONCLUSION

In recent years, the World Economy has witnessed two important crises – the Global Financial Crisis that originated from the US sub-prime crisis in 2008 and most recently the Euro Zone crisis that initiated from the Debt Crisis of Greece in 2011. These crises have wobbled the backbone of the world economy in terms of decline in gross national products, rise in unemployment rates, adverse exchange rate scenario, and slump in the rate of capital formation. Although the epicentre of crises was west, many developed and developing nations have been the victims of these problems. And, India is no exception. The crises mainly transmitted to India through financial and trade channels. Since India is more integrated with the world financial markets, particularly with international capital markets, the crises immediately resulted in increase in market volatility, slump in trading volume, and plunge in investors’ confidence. Thus, the capital market of India crashed after massive

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P. K. Mishra

withdrawals by domestic and foreign investors. Despite, Indian economy showed an appreciable resilience in terms of rapid revitalization of macroeconomic indicators. Regarding the Eurozone crisis, India has been least affected. It is with this backdrop, this paper attempted to make an empirical appraisal of the performance of the Indian capital market in terms of the key market parameters including size ratio, liquidity ratio, turnover ratio, market volatility, and market efficiency. The study provides the evidence of growing market size, liquidity, greater volatility and weak form inefficiency. In this context, it may be suggested that the planners, policy makers and regulators should make the national economy more robust by devising, through market reforms, the prudential norms and international best and fair practices. It is at least learnt that ‘slow and steady win the race’, but not the ‘Rabbit Run’. Notes 1.

In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point. This aspect of the rule is often called the Taylor principle.

2.

‘Originate and distribute’ is the practice under which a bank does not hold the loans that it originates, but distributes them to other financial institutions after they have been repackaged and converted into bonds by securitization.

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