THE SHIFTING TRENDS OF INDIAN FOREIGN EXCHANGE IN THE POST LIBERALISATION ERA

Author: Divyanshu Saxena, V year of B.A.,LL.B. from NALSAR University of Law, Hyderabad

ABSTRACT

The major stock markets that prevail in the Indian Economy are – National Stock Exchange of India Limited (NSE) and Bombay Stock Exchange of India Limited (BSE). The Indian Market is deeply dependent on the virtual flow of cash that takes place within these institutions. The shareholders invest their capital in these exchanges and the revenue of the nation is generated in the form of GDP (Gross Domestic Product), which is a cumulative sum of all the resources and monetary returns.

In 1991, the government of India took a conscious decision of liberalising the economy, to give enough space for the expansion of production. The implementation of economic policies like reduction of import duties, greater foreign investments, de-regulation of markets and decreases in taxes has led to the globalisation of the Indian Market. A large number of internationally established MNCs have set up their manufacturing units in the country, which has led to increased rates of employment and quality of life. The immediate response to the liberalisation process was the end of the vicious cycle of “Licence Raj”, destruction of the public monopolies and reduced tariffs. The Reserve Bank of India (RBI) realised the decline that followed the economic crisis (1985-1990) and refused the further provisions of Foreign Exchange Reserves and approved the stabilization of the economy through the process of liberalisation.

KEYWORDS – “Indian Economy”, “Flow of Cash”, “Liberalisation”, “Globalisation”, “Foreign Exchange Reserves”

SUMMARY

STOCK MARKET IN A LIBERALISED ECONOMY: INDIAN EXPERIENCES

The above article was published in the Economic & Political Weekly (EPW) on January 27, 2001, in the wake of the significant changes in the stock exchange functioning of the Indian economy, post the government’s adaptation of the liberalisation policies. The article revolves around the notions of the adverse effects being faced by the Indian Stock Exchanges and the impacts of liberalised economy on the de-regulation of the market forces. The author, MK Roy, talks about the extensive debates that were going on over the question of market reforms and underlines the important arguments of both sides. On one hand, the people criticizing the anomalous behaviour of the stock market after the liberalisation of the economy, argue that the market reforms leading to the better regulation of the cash flow must be implemented through stringent economic policies for controlling the flooding of the huge globalisation funds. On the other hand, the people in support of the independent markets questioned the validity of these reforms and rendered these useless by proving that this may lead to over-speculation of the market, financial crisis and misallocation of the resources in the private sector.

“ There is no consensus in the scholarly literature about the possible impact of deregulation on the efficiency of the market. Reformers confident about the beneficial role of the stock market in a free economy tend to undermine the scope of its unruly behaviour in the post-liberalisation period. Those who oppose it often argue that stock market reforms may lead to over-speculation, financial crisis and misallocation of savings and investments to the detriment of real sector growth and stability.”[1]

The article also considers the formation of equity markets, in the wake of liberalisation, as a common phenomenon in the economy of less developed countries (LDCs). The stock exchange was flooded with innumerable shares being bought by the masses, and newly-born firms started having a dominant influence on the Indian economy. The behaviour of the market transformed to more volatile forms, where the sudden changes in the laws of demand and supply became more frequent, and the profit-maximization strategies went through ground-breaking reforms. Hence, the gist of the article has been explained in the following lines by the author,

“Policy-makers of the developing economies are aware of the fact that foreign investment produces and reproduces a calamitous effect on LDCs economy. Yet, for obvious reasons they suffer from the dilemma: integration or separation of the financial system from the international market. Separation is considered as too costly given the possible loss of access of excess funds of developed countries, hence, it is treated by most LDCs as unrealistic and undesirable.”[2]

STOCK MARKET DEVELOPMENT IN INDIA: IS THERE ANY TREND BREAK?

The article was published on 2 February 2001 in the economic and political weekly (EPW)to analyze the stock exchange rate changes and trends being displayed in the market economy which has been deeply influenced by the liberalisation policies of the year 1991. The author, Pratap Chandra Biswal, talks about the important impacts of economic liberalisation on the stock exchange and highlights the three significant stock market indicators of change- size, liquidity and volatility. “This study considers a wide range of stock market development indicators. We begin with the market capitalisation ratio (MCR) which is considered as a measure of stock market size. The MCR is defined as the value of listed shares divided by GDP.”[3]

The wide-ranging possibilities put forward by the space provided in the globalised economy led to increased flexibility in the market, and a large number of innovative market techniques surfaced, and the people started using the government policies for their benefit. The reports display that the privatisation of the resources in the post-liberalisation era led to the unequal distribution of wealth and market control amongst the competitive firms of the various industries.

“It is worthwhile to note here that since financial markets are forward-looking, value trading has one potential pitfall. If markets anticipate large corporate profits, stock prices would rise today. This price rise would increase the value of the traded shares and therefore raises the value traded. Problematically, the liquidity indicator would rise without a rise in the number of the transactions or a fall in transaction cost.”[4] The paper evaluates the behavioural characteristics of the liberalised economy through the measures of market volatility, import duties and revenue generation. The author concludes by emphasizing the impact of extensive privatisation on resource distribution and explains the cause-effect relationships between the various market phenomena, in the light of the expansion of the Indian economy post-liberalisation.

CAPITAL INFLOWS DURING THE POST-LIBERALISATION PERIOD

The above article was published on 29 January 2001 in the Economic and Political Weekly (EPW) which was tracing the analysis of the country’s quarterly returns earned over the cash inflows initiated by the liberalisation policies. The real exchange rates of the stock market are deeply affected by the macro-variables present in the Indian economy. The author, Indrani Chakraborty, talks about the adjustments being made in the cash inflows to cope up with the increasing market expectations.

“The Indian experience with the liberalisation of foreign private capital inflows, however, has been somewhat different from that of the Latin American and the east Asian countries. The much-discussed currency crises of the 1990s, viz, in Mexico in 1994 and east Asia in 1997-98, all followed financial liberalisation measures in those countries, which raised questions indicating possible linkages between liberalisation and crisis.”[5]

The macro-economic variables are the dynamic feature characteristics that impact the stock exchanges rate of share flows within the equity markets. The reports referred to by the author underline the cointegration relationship between the real exchange rates and the market differential rates. The intervention of the Reserve Bank of India was necessary to decrease the volatility of the Indian Economy.

“The general sequence of events goes like this. Capital inflows exert pressure on nominal and real exchange rates, which lead to intervention by the central bank in the foreign exchange market. As a consequence, reserve accumulation accelerates and monetary control becomes more difficult. Attempts to sterilise the foreign exchange transactions through either open market operations or increases in reserve requirements lead to an increase in the interest rate, which, in turn, raise the quasi-fiscal cost of the central bank.”[6]

Hence, the article concludes the coherent relationship between the market changes and the shift in the dynamic equilibrium present within the economy. The market control forces determine the degree of shift in the stock exchanges caused due to the apparent changes in the market strategies.

INDIAN STOCK MARKET IN COMPARISON

The article was published on May 6, 2006, in the economic and political weekly, with the sole objective of evaluating the functioning of the Indian stock market and comparing it with the functioning of other stock exchanges across the globe. The statistics obtained by the Reserve Bank of India (RBI) display that there has been a large-scale expansion in the economy post-liberalisation and the exchange of large monetary amounts has become an important part of the Indian economy.

“Financial sector reform in India has been successful in-bringing significant improvements in various market segments by effecting regulatory and legal changes, building up institutional infrastructure, constantly fine-tuning in the market microstructure and substantial up-gradation of technological infrastructure.”[7]

The expansion in the Indian market has been accompanied by the regress in the quality of products being circulated in the economic exchanges. The over-saturation of the profit maximization strategies in the competitive firms has led to the degradation in the level of product quality being offered to the consumers as compared to the liberalised economies of the other less developed countries (LDCs).

“But in terms of quality, there has been a regression. In the post-reform era, trading in the Indian stock market became increasingly concentrated in a few sectors and companies; the increase in annual turnover is mainly attributable to this greater concentration on a few companies and sectors”[8]

The author concluded the discussion over the conflict between the expansion of the market opportunities and its relative effects on the quality maintenance of the products, by suggesting strict quality control legislations being levied upon the producers by the government. Also, the discussion furthered towards the changes in share-price volatility after the globalisation process dominated in the post-liberalisation economic scenario.

STOCK MARKET PRICES IN INDIA AFTER ECONOMIC LIBERALISATION

The article was published on 14 February 1998 in the economic and political weekly (EPW) for evaluating the liberalised economic propositions of the Rajiv Gandhi administration and the critical analysis of how the globalisation process has unfolded in the Indian context since 1991. The non-parametric study of the market behaviour by the author has led to the tracing back of the market patterns in the economic history of the country.

“The question that this article examines is how has the behaviour of Indian stock prices changed in the wake of this movement towards economic liberalisation? The efficient markets hypothesis in finance suggests that as markets are made more open to the public, prices should come to reflect the increased availability of information and be more efficiently priced.”[9]

The article revolves around the scale of efficiency in the working of the Indian stock exchanges, and how the behaviour of these share equity markets affect the prices prevailing in the particular period. Also, the long-awaited market-oriented economic model of the Indian economy started becoming prevalent, running parallel to the economic freedom provided by the government’s policy of liberalisation.

“In the middle of the 1980s, however, this character of the Indian economic system began to change as the Rajiv Gandhi administration began several economic reforms that signified the beginning of India's prolonged movement towards market-oriented, liberalised economic policies. Over the next decade, subsequent governments would continue to push through several economic reforms.”[10]

The author concluded the article by emphasizing the intervention of stringent economic reforms in the Indian market and re-evaluating the functioning of the Indian stock exchange to increase the predictability of share profits amongst the masses. This is also necessary to separate the unwanted invisible forces of the market like cheating, fraud, deception to increase consumer safety in the market economies.

COMPARATIVE ANALYSIS

The various articles provided in the course of this review, deal with the analysis of the economic liberalisation policies of 1991 and the manifestations produced due to these policies in the economy. The articles also draw a line of relationship between the working of the stock exchange markets and the influence of the globalisation process on the Indian economy. In his article, MK Roy talks about the privatisation of the resources being becoming dominant with the increasing freedom in the market. This could be related to the issue of individual control over the market profits i.e.monopoly becoming a threatening reality for a certain economy.

“There is a widespread acceptance of the proposition that banks constrained with imperfect information misallocate resources of the suppliers of the fund; faulty pricing in the equity market also provokes people to make the same mistake. Thus the difference is the simple direct and indirect misallocation of resources - both retards growth of the economy.”[11]

The literature also highlights significant information about the various Market Indicators that are present within an economy and reflect the profit maximization conditions for the various competitive firms. These indicators are generated through the laws of demand and supply of economics and are the differential measure of how the market predictability and profit possibilities change. These are governed by the apprehensions created in the minds of the consumers by the producers through a large number of market strategies like advertising, share buyouts and other exchanges.

“In India, the stock markets remained backwards until the 1980s with little scope for expansion in a regime dominated by state-directed credit. The reform of the regulatory framework began in the late 1980s with the establishment of Securities and Exchange Board of India (SEBI), but gained significant momentum with the consolidation of all regulatory authorities with SEBI in 1992.”[12]

Indrani Chakraborty talks about the capital inflows that regulate the functioning of the stock exchanges and what impact they face when they are subjected to the increasing market volatility of the liberalised economy. Her analysis clearly shows that the RBI intervention in preventing the foreign reserves exchange was critical in rescuing the declining economy of the country. Although, that led to the liberalisation of the economy and the country’s economic macro-variables developed significantly. This is how the prices keep on changing in the market, and the share-allocation also changes accordingly.

“The study observes that capital inflows respond to the short-term macroeconomic policies of the capital importing country. The study finds that certain domestic macroeconomic policies, such as sterilised intervention, increase the volume of total capital flows mainly through increased short-term flows. On the other hand, measures aiming at capital controls seem to have no significant effect on reducing the volume of capital flows.”[13]

Matthew R. Morey highlights the fact that the economic reforms suggested during the liberalisation process are the control authority over the market equity prices existing within the domain of a specific economic model. He also underlined the principle that the behaviour of the Indian stock exchange patterns follows Fama’s efficient market hypothesis.

“In other words, since the current price reflects all available information, including information about the future, it is a very good predictor of the future price. The only difference between today's price and tomorrow's price are events that we cannot predict, i e, random events. Hence, in an efficient market, stock prices should behave as a 'random walk' process when statistically tested.”[14]

Joydeep Biswas added to the stock exchange behaviour patterns, by underlining the quality control factors being affected by the expansion of the Indian economy in the post-liberalisation scenario. He highlighted the trend that trading has become predominantly common in only a few manufacturing sectors and there exists an apparent disparity in the division of market control which allows such quality degradations to slip into the market system.

“As far as allocative efficiency is concerned, it is confined to only a few liquid shares and the bulk of non-specified shares do not have that much marketability, which rather reflects the sheer misallocation of funds. Moreover, in respect of volatility, the market does not exhibit any radical change[15]”

The perspectives of these various authors converge at the concern of the implementation of immediate economic reforms to control the deterioration of the functioning of the Indian Stock Exchanges. Moreover, they also agree upon the fact that there has been a significant increase in the flow of capital into the transactions of the country’s economy.

“Policy-makers of the developing economies are aware of the fact that foreign investment produces and reproduces a calamitous effect on LDCs economy. Yet, for the obvious reason, they suffer from the dilemma: integration or separation of the financial system from the international market.”[16]

CONCLUSION

The comprehensive study of the articles provides us with important features of how the Indian economy behaved in the changing government policies and its direct effect upon the historical Indian stock exchanges. The literature talks about wide-ranging topics like market volatility and the equity markets that are the phenomena noticed within an expanding economy. The further close analysis shows that there is a deep relationship between the apprehensions in the minds of the consumers and the market predictability of how the shares of the various competitive firms are distributed amongst the buyers. There was also a detailed comparison between the responses of various other less developed countries (LDCs) to the liberalisation policies in their economic structure and on what lines the Indian model has proved to be beneficial for the development of the country and upholding the stock exchange rates within the economy. The market indicators have measured the space available within the economic freedom of the country and have established a specific line of profit possibility, along which the companies set their resource allocation goals. Therefore, the behaviour of the liberalised Indian economy has been positive for the time being, and the increasing actions towards the development of cottage industries and capitalization of the local production houses are proving to be a successful move towards the economic development of the country.

[1] [Singh 1993, Grabel 1995]

[2] Economic and political weekly Vol. 36, No. 4,

[3] Economic and political weekly Vol. 36, No. 4,

[4] Economic and political weekly Vol. 36, No. 4

[5] Economic and Political Weekly, Vol. 41

[6] Economic and Political Weekly, Vol. 41

[7] Economic and Political Weekly, Vol. 41, No. 18

[8] Economic and Political Weekly, Vol. 41, No. 18

[9] Economic and Political Weekly, Vol. 33, No. 7

[10]Economic and Political Weekly Vol. 33 No. 7

[11] Economic and political weekly Vol. 36, No. 4,

[12] Economic and Political Weekly Vol. 36 No. 4

[13] Economic and Political Weekly Vol.41 No. 2

[14] Economic and Political Weekly Vol. 33 No. 7

[15] Economic and Political Weekly Vol. 41 No.18

[16]Economic and Political Weekly Vol 41 No. 2