The Growth of the Indian Capital Market

In one line

India's capital market grew because four things were done in sequence: a statutory regulator, an electronic national exchange, dematerialisation, and the opening of the market to foreign and then to household money.

In the wording a student can write in an exam: the growth of the Indian capital market may be traced through its early history from 1875, the period of controlled capital issues until 1992, the reforms beginning with the repeal of capital issues control and the conferment of statutory status on the Securities and Exchange Board of India, the introduction of electronic screen based trading and of dematerialisation under the Depositories Act 1996, the shortening of the settlement cycle, the admission of foreign portfolio investment, and the very rapid expansion of retail and mutual fund participation in recent years.

Phase one: the market before independence

The Native Share and Stock Brokers Association was formed in Bombay in 1875 and is the oldest stock exchange in Asia. Trading was in physical certificates, membership was closed, and the market served a small number of families and firms.

Phase two: control, 1947 to 1991

The Capital Issues (Control) Act 1947 required government approval for a capital issue and for the price at which it was made. A company could not decide how much to raise or at what price; the Controller of Capital Issues decided. Prices were fixed administratively, usually below what the market would pay.

What that produced. A primary market in which issues were routinely underpriced and therefore oversubscribed, allotment by lottery, and a listing gain that had nothing to do with the company's prospects. It also produced a market in which the decision to invest was in effect made by an official.

The Securities Contracts (Regulation) Act 1956 provided for the recognition and regulation of stock exchanges, and remains the statute under which an exchange is recognised.

Two events that shaped the period. The Foreign Exchange Regulation Act 1973 required many foreign companies to dilute their holdings, which brought a number of large issues to the Indian public and widened share ownership. And the securities scam of 1992 exposed how weak the settlement and supervisory systems then were, which gave the reforms that followed their urgency.

Phase three: the reforms, from 1992

Four measures, and the sequence matters.

1. Abolition of capital issues control, 1992. The Capital Issues (Control) Act 1947 was repealed and companies became free to decide the amount and the price of an issue, subject to disclosure. Pricing moved from an official to the market, and disclosure became the protection in place of price control.

2. Statutory status for SEBI, 1992. Section 3 of the SEBI Act 1992, described in [Features of the Indian Capital Market and the Role of SEBI]. A market freed from price control needed a regulator of conduct and disclosure, and the two measures are two halves of one decision.