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Emerald Group Publishing Limited. Please share your general feedback. You can start or join in a discussion here. Visit emeraldpublishing. Abstract Purpose — The purpose of this paper is to construct a financial development index FDI for the Indian economy and also examine the relationship between FDI and economic growth. Please note you might not have access to this content. The daily volatility of the yields has been declining indicating, inter alia , maturity of the government securities market Gopinath, With the issuance of long-term securities, the yield curve has emerged for across 30 year maturity Chart 1.

Finance and Growth

Notwithstanding these improvements, the government securities market continued to be illiquid at the long end. Further, the major investors in the government securities are institutional investors, who hold securities to maturity, on account of statutory prescriptions, which makes the market illiquid.

With the permission to FIIs to invest in dated government securities and T-bills with certain specified limits, the secondary market is expected to be more liquid. A well—developed bond market is important to ensure a well-integrated financial system. Before the s, the corporate bond market was dormant on account of control on the interest rates for corporate bonds as well as limited issuances in the market were also dominated by public sector companies issuers and banks buyers Rajaram, et al The first reform in the corporate bond market was the abolition of ceiling interest rate for corporate bonds on May Thought, the primary issuances have been significant, most of these were accounted for by public sector financial institutions and were issued on a private placement basis to institutional investors.

The secondary market, therefore, has not developed commensurately and market liquidity has been an issue Reddy, Major reforms have started in the corporate bond market following the recommendation of the High Level Committee on Corporate Bonds and Securitisation Government of India, on corporate debt market in India. The corporate bond market in India continues to be nascent despite measures taken from time to time over the past fifteen years based on the recommendations of several official committees.

However, in recent years, the corporate bond market has shown significant growth in terms of outstanding stock and volumes traded in the secondary market Table 3. The Indian forex exchange market was virtually nonexistent from the s to s as India was using trade controls to foster import substitution. The origin of forex market can be traced to the year , when banks in India were allowed to undertake intra-day trade in foreign exchange RBI But the market was very limited as India followed a fixed exchange rate system.

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In the s, as in other segments of financial markets, various reforms were taken in the foreign exchange market. The introduction of market-based exchange rate regime in , adoption of current account convertibility in , and substantial liberalization of capital account over the years were the most important reforms in the forex market. The reforms in the forex market were focused on dismantling controls, developing the institutional framework and increasing the instruments for effective functioning, enhancing transparency and liberalizing the conduct of foreign exchange business RBI Market participants have been provided with greater flexibility to undertake foreign exchange operations and manage their risks through simplification of procedures and availability of several new instruments Mohan, At present, the foreign exchange forex market is divided into two segments: over the counter OTC market which includes spot, forwards and swaps and exchange-traded currency futures.

The BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in estimated that the percentage share of the rupee in total foreign exchange market turnover covering all currencies increased from 0. Among the forex market, the spot market continues to be the dominant in India. Within the OTC foreign currency segment, the spot market has remained the most active accounting for almost 48 per cent of the total turnover, followed by swaps As a result of various reforms, the liquidity in the foreign exchange market has increased manifold over the years.

The forward premia is generally aligned with the interest rate differential, reflecting growing market efficiency Mohan However, still there are issues such as transparency in the currency market from the view point of customers, as banks do not unbundle the price on the currency market as opposed to their intermediation fee Shah et al The banks also charge very high intermediation costs. Before the initiation of economic reforms in the early s, the Indian stock market was governed by a plethora of complex regulations and extensive restrictions.

The economic reforms in the capital market were started with the establishment of securities and exchange board of India SEBI. The reforms have focused on the regulatory effectiveness, enhancing competitiveness, reducing information asymmetries, developing modern technological infrastructure, mitigating transaction cost in the securities market Mohan As part of the reforms, the foreign institutional investors FIIs were allowed in to participate in the market, the Indian corporate sector were allowed to raise funds in the international market through American depository receipts ADRs and global depository receipts GDRs , foreign currency convertible bonds FCCBs and external commercial borrowings ECBs , investment in Indian companies by non-resident Indian NRIs and overseas corporate bodies OCBs subject to certain conditions.

The introduction of national stock exchange NSE in increased the competition in the market leading to significant rise in the volume of transactions. In the exchange- traded market, Index futures were introduced in June , followed by index options in June , and options and futures on individual securities in July and November , respectively. The various reforms had a great impact on the Indian capital market and it has become one of the fastest growing capital markets in the world. The introduction of exchange traded derivative instruments such as options, futures in has enabled investors to better hedge their positions and reduce risks.

As of March , the NSE traded in futures and options on individual stocks and four stock indices. All these derivative contracts are settled by cash payment and do not involve physical delivery of the underlying product. FIIs have an increasing presence in the equity derivatives markets and currently contribute around 22 per cent of the market turnover. Where do all the details of market microstructure lead us to?

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A priori , we expect certain kind of integration between domestic financial markets based on the commonality of key players in the market as well as nature i. We expect that the money market and forex market to be integrated, on account of short term nature of both markets as well as key role played by the commercial banks in both these markets.

We also expect certain integration between the forex market and the stock market on account of key role played by the FIIs. The FIIs investments in stock markets have increased over the period and they play a major role in the segment. With the increased exposure in the stock market, they may hedge their exposure in the foreign exchange through the forward market. We also expect close integration between government securities yield and yield on corporate bonds, as government securities yields are the risk free assets and corporate bonds are priced over and above their risk free government securities yields based on their risks.

To begin with, some details on the data used in rest of this study are in order. For the domestic market integration, we have used the following variables from the four market segments:. These apart, for the monetary policy transmission, we have derived effective monetary policy rate using the repo Rate, reverse repo rate and amounts under the net liquidity adjustment facility LAF. As far as source of the data are concerned, while all the money market rates are taken from the CCIL, other market rates are taken from the Bloomberg.

The Indian financial markets, during the period under study January November , in general, remained orderly, even though at periods, it was affected by certain external events such as global financial crisis Chart 3. The call money market, in general remained orderly, and was influenced by the liquidity in the system as well as the monetary policy measures.

The CBLO and money market rates also showed same trends albeit at a lower rate than the call money rates. The periods in which there was some volatility in the money market rates during the period under study are briefly described below. During January to March , the call money rates firmed up due to the redemption of the India Millennium Deposits IMDs amidst sustained credit growth and build-up of cash balances by the Government of India.

Research Article

The period March 20 — 30, witnessed abnormal situation in money market. After easing to below the reverse repo rate between March , , the call rate hardened substantially and averaged Various factors are attributed to this abnormal movement in call rates, such as tightening of liquidity conditions due to advance tax outflows, year-end considerations, sustained credit demand and asymmetric distribution of holdings of Government securities across the banks RBI, The money market reached its normalcy with the beginning of the new financial year on April 1, After the withdrawal of daily reverse repo ceiling effective August 6, , the rates in the overnight money market increased in August RBI , to around the reverse repo rate.

During the financial crisis, on account of liquidity supporting measures taken by the RBI, the call money rates eased significantly during October to May period.

Finance & Development, March - Up or Down

From June onwards, the call money rates moved up reflecting the tight liquidity and the monetary tightening measures taken by the RBI to curb inflation in the economy. Yields in the Government securities market generally hardened from January to August , but declined sharply thereafter following the monetary easing by the RBI due to global financial crisis. But from onwards, the government securities yield started hardening again reflecting the increase in the government market borrowings, inflation persistence and policy rates hikes by the RBI.

The year corporate bond market yield also followed the same trend as of the government securities yield. In the foreign exchange market, the Indian rupee exhibited two-way movements during the period under study. The exchange rate, which more or less remained stable during , started appreciating from mid-July onwards mainly due to capital inflows into India. During mid- to mid- , the exchange rate depreciated against the US dollar, as Reserve Bank followed expansionary monetary policy in the aftermath of the global financial crisis. Thereafter, the exchange rate started appreciating reflecting the inflow of capital and monetary policy tightening on account of persistence of inflation.

Towards the end of , the exchange rate depreciated reflecting adverse global sentiments and moderation in capital flows. The capital markets were buoyant and reached highs during August , driven by increased interest by domestic as well as foreign investors on the back of strong macroeconomic fundamentals. With the impact of global financial crisis being felt in India, the capital market was in a subdued mood during August April , but thereafter it started becoming buoyant as foreign investors were attracted by the high return and higher growth story of the Indian economy.

However, subsequently, during September — December , reflecting dampened global sentiments on account of Euro zone debt crisis, the stock market declined. The descriptive statistics of these variables reveal a number of interesting trends Table 5. The coefficient of variation of money markets and stock markets are higher than bond and forex market. The skewness is positive for call rate, exchange rate and 10 year AAA corporate bond yield, while other financial market variables are negative, indicating that there is an asymmetry of the probability distribution. All the variables except CBLO, market repo and stock price displays a kurtosis of more than 3, thus indicating the density function is characterised by fat tails. Interestingly, a key consideration in the extent of monetary policy transmission to financial markets and onwards to the real sector is the integration of the financial markets.

If the markets are weakly integrated, the transmission may not be effective, and may force monetary authorities to act separately in each segment of the financial markets.

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  6. If the market is greatly integrated, the monetary policy transmission is fast to the financial markets, which can have the desired effect in the real economy. Thus, degree of integration plays a key role in the effective transmission of monetary policy signals. What has been the extent of association among the rates in the different segments in the financial markets?

    The correlation structure for the whole period i.

    Subhanil Chowdhury

    The high correlation also indicates improvement in efficiency in the operations of financial intermediaries trading in different instruments RBI, The money market instruments and 10 year government securities yield show moderate correlation, as money market is a short term and the 10 year G-sec is a long term market, even though dominant role played by commercial banks. As expected, there is higher degree of correlation within the bond market i. The exchange market is positively correlated with all other markets than expected negative sign, but has lower degree of correlation.

    This could be due to excessive capital inflows to India during the period of study, which could only be partially explained by the interest rate differential between India and foreign countries. The other factors are search of better yield by foreign investors and strong macroeconomic fundamentals in India could have attracted more flows to India. The stock market shows unexpected positive correlation with exchange rate, but the degree of correlation is low. How is monetary policy conducted in India?

    Before analysing the behaviour of the monetary policy rates, it may be useful to have a brief overview of the monetary policy operating procedure in India.