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Master of Arts

ECONOMICS (MAEC)

MAEC-08

INDIAN ECONOMIC POLICY

Block – 4

SECTORAL PERFERMANCE-2

UNIT-13 INFRASTRUCTURE

UNIT-14 INDIAN FINANCIAL SYSTEM: MONEY MARKET AND

MONETARY POLICY

UNIT-15 CAPITAL MARKET IN INDIA AND WORKING OF

SEBI

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UNIT 13 INFRASTRUCTURE

Structure

13.0 Objectives 13.1 Introduction 13.2 Concept and Meaning of Infrastructure 13.3 Characteristics of Economic Infrastructure 13.4 Role of Infrastructure in the Economy 13.5 Policies and Performance of the Economic Infrastructure

13.5.1 Transport Infrastructure 13.5.1.1 Roadways 13.5.1.2 Railways 13.5.1.3 Seaports and Airports

13.5.2 Energy Infrastructure 13.5.3 Communications 13.5.4 Banking Infrastructure

13.6 Growth Rates of the Economic Infrastructure 13.7 Inter-State Disparities in Infrastructure Stocks 13.8 Components of Social Infrastructure in India

13.8.1 Health 13.8.2 Education 13.8.3 Other Areas

13.9 Assessment of Social Infrastructure Performance 13.10 Policies for Social Infrastructure Development 13.11 Implementation Issues 13.12 Let Us Sum Up 13.13 Exercises 13.14 Key Words 13.15 Some Useful Books 13.16 Answers or Hints to Check Your Progress Exercises

13.0 OBJECTIVES

After going through this unit, you will be able to:

• explain the meaning, concept and characteristics of infrastructure;

• establish the linkage between economic and social infrastructure and development;

• assess the performance of various constituents of infrastructure in the wake of economic reforms;

• evaluate the inter-state disparities in economic infrastructure; and

• identify the issues and problems faced in the implementation of infrastructure projects.

Sectoral Performance-II

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13.1 INTRODUCTION

Infrastructure plays an important role in the development of an economy. The adequacy or lack of it determines an economy’s success or failure in increasing production, expanding trade, reducing poverty and improving environmental conditions. Infrastructure is of two types: economic and social. In this unit, we shall discuss the performance of various components of economic and social infrastructure, their growth and trend, inter-state disparities and implementation related issues. Let us begin with stating the concept and meaning of infrastructure.

13.2 CONCEPT AND MEANING OF INFRASTRUCTURE

Infrastructure sectors are the backbone of a national economy. It has been commonly opined that infrastructure development is closely related to economic growth and poverty reduction. Therefore, development plans of all countries, particularly those of the less-developed countries, are aimed at the development of infrastructure sectors through sector specific policies, which, in turn, generate sustained economic growth.

The word “infrastructure” is defined in dictionary as “the underlying foundation or basic framework” (See Webster’s Ninth Collegiate Dictionary, 1985, p. 621). By this definition, infrastructure is the basis for development. In other words, infrastructure is taken as the foundation on which the factors of production interact in order to produce output. Infrastructure, in the general sense, is taken to refer to large-scale public systems, services, and facilities that are necessary for economic activity. Broadly, infrastructure includes all public services from law and order through education and public health to transportation, communications, power and water supply, as well as irrigation and drainage systems.

Infrastructure can be classified as ‘economic infrastructure’ and ‘social infrastructure’. Economic infrastructure comprises of sectors that have capital investments on hardware as a significant component. On the other hand, social infrastructure sectors like health, education etc. have less significant capital investments. Transport sector (Roads, Railways, Airports, Seaports), Energy facilities (Power, POL infrastructure, terminals, pipelines), Communication facilities (Telecom, Posts), and Banks are the important constituents of economic infrastructure.

13.3 CHARACTERISTICS OF ECONOMIC INFRASTRUCTURE

There are five important characteristics of infrastructure services. They:

a) are generally natural monopolies;

b) have large upfront costs and long payback periods;

c) involve lumpiness or indivisibility of investments;

d) are marked by presence of externalities, and

e) sunk costs.

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InfrastructureNatural monopoly is the situation where the provision of a good or a service has economies of scale, which are realised most when a single firm produces the entire output. If a private firm provides these services, it charges high prices and makes huge profits. Hence, Government intervention is required either to regulate the private firm or to replace it. Large upfront costs and long payback periods associated with infrastructure provision make it difficult to finance and manage. Investment in infrastructure is characterised by lumpiness or indivisibility, which implies that large amounts are required at a time. Externalities occur if the benefits or costs of producing or consuming a good affects person other than the individuals involved in a transaction. In fact, this reveals the “public good” nature of infrastructure. Public good possesses two characteristics viz., ‘non-rival’ and ‘non-exclusive’. Non-rivalry implies that infrastructure can be enjoyed by an extra person without reducing the enjoyment it gives others. Non-exclusiveness implies that people cannot be excluded from consuming the good. Sunk costs are the costs that have already been incurred and which cannot be recovered to any significant degree. Sunk costs can be taken as the opposites of incremental costs. Incremental costs are the costs that will change due to the proposed course of action. Only incremental costs are relevant to a decision. Thus, large volumes, sunk costs, long periods of amortisation, and prolonged project development makes the infrastructure sector investment highly risky. In addition to these main characteristics, infrastructure services have low elasticity of demand. It implies that the demand for these services is not much affected by the prices.

13.4 ROLE OF INFRASTRUCTURE IN THE ECONOMY

Economic Infrastructure produces services that directly facilitate and are basic to the carrying out of a wide variety of economic activities. Infrastructure contributes to development both directly and indirectly. The output or the final products of different segments of infrastructure is the direct effect. Infrastructure’s indirect contribution is as an intermediate input that enhances the productivity of all inputs of different sectors. For example, the quality of labour is enhanced by human capital improvements. Similarly, productivity of physical capital is improved by power and transportation etc.

The linkages between economic infrastructure and development are as follows:

• Infrastructure lowers the cost of producing a given level of output or, alternatively, can increase the amount of output produced by all other inputs for a given cost.

• Infrastructure enables markets to work better. Transactions are made less costly and this increases the benefits of trade. For example, advances in transport and communications have considerably lowered storage costs by permitting producers to respond rapidly to changing consumer demands even in international trade. (this is referred to as “modern logistics management”).

• Unit costs tend to rise due to unreliable or inaccessible public infrastructure. Both small and big firms spend a significant portion of their expenditure on buying infrastructure services and suffer when these are not available. Electricity shortage has been a notorious constraint faced by expanding business units.


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13.5 POLICIES AND PERFORMANCE OF THE ECONOMIC INFRASTRUCTURE

13.5.1 Transport Infrastructure

The development of transport infrastructure plays an important role in the growth process through increasing mobility of resources and increasing factor productivity. Transport infrastructure saves time and decreases the cost of transportation, and, thereby, helps both the rich and the poor. Transport development in rural areas strengthens linkages between towns and the countryside. Along with irrigation, it helps adoption of new technology by reducing the cost of inputs and marketing of outputs. It helps the rural poor by increasing their accessibility to schools and health centres and enables them to obtain non-farm employment in far-away places. In India, the share of the transport sector in Gross Domestic Product in 2003-04 was 5.55 per cent (calculated at 1993-94 prices). Roads, Railways, Airports, and Seaports are the infrastructure constituents of Transport Sector.

Each of these constituents of Transport Infrastructure is highlighted in the following paragraphs.

13.5.1.1 Roadways

Road transportation carries 85 per cent of the passenger and 70 per cent of the freight traffic. Roads are divided into five categories for administrative purposes. They are National highways, State highways, major district roads, other district roads and village roads. Highways, both national and state, perform main mobility function while the other roads provide accessibility to meet social needs besides the means to transport rural produce to the markets. Highways constitute only 2 per cent of total road length in the country but account for 40 per cent of traffic. The Central Government is responsible for the maintenance of National highways, and State Government looks after other roads.

Main features of road transportation in the country are:

a) Till recently, there has not been much improvement in the national highways development as much of the development is taking place in building rural access roads, which provide connectivity to villages.

b) Poor quality of main roads: Highways have not been keeping pace with the traffic growth. Poor quality of roads has become a main factor for deteriorated riding quality, congestion and slow average speeds.

Thus, poor quality and inadequate growth of highways, has been causing transportation costs and economic losses which, in turn, are resulting in erosion of international competitiveness of Indian firms. Road congestion, existence of number of railway level crossings, and octroi posts are the other factors contributing to the economic losses that occur due to bad conditions of roads.

After the introduction of the liberalisation policies in 1991, a number of policy measures have been brought into effect. The National Highways Act was amended in 1995 to allow private sector participation. The NHAI (National Highways Authority of India) has been mandated to implement the National Highways Development Project comprising strengthening and upgrading to a

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Infrastructurefour-lane status of about 13,000 km of high-density corridors. Norms for foreign investment in the road sector have been liberalised. Funds have been made available to the NHAI for its capital base through a tax on motor spirit and cess on diesel. Plans for further improvements in Highway development, including provision of Expressways linking the busiest corridors are being drawn up.

13.5.1.2 Railways

Indian Railways (IR) has been playing a key role in integrating the country from the economic perspective, railway services are intermediate inputs to production; any reduction in these input costs raises the profitability of production. For domestic firms to be competitive in the world, the cost of infrastructure – among them prominently, the cost of transport services – also has to be competitive with that in other countries. Railways provide energy efficient form of transportation compared to roads. By the end of year 2004, the network of Indian Railways was spread over 63,221 route kms. Out of this network, 46,807 route kms are Broad-gage, 13,290 route kms are Metergauge and 3,124 route kms. are Narrow-gauge. Traditionally, railways are seen as part of essential public service implying that the usage of railways should not be denied to even those who are unable to pay fully. Cross subsidisation of services is practised: freight charges and upper class passengers charges are set high and used to subsidise lower class passenger costs. Passenger traffic currently contributes around 30 per cent of total revenues and the rest (70 per cent) comes from freight traffic.

IR is facing problems from two sides, drop in resources required for development and increased competitive pressures from other modes of transport. Railways have been steadily losing its market share of freight to road largely because it has not been able to compete on prices. The proportion of the total production of bulk commodities that is transported by rail has been going down in almost all commodities. Road transport dominance is increasing with the measures the Government has already set in motion for the road sector like the four-laning of the “Golden quadrilateral” and the development of new expressway stretches. The increasing use of pipelines for the transportation of petroleum products is also contributing to the fall in demand for rail services. Moreover, in recent times, coal and cement have started moving in significant volumes through coastal shipping.

To address the issue of inadequate finance, IR has identified areas for private participation. Gauge conversion, doubling of existing single lanes, electrification projects, supply of rolling stock such as wagons and passenger coaches are opened for private participation.

Check Your Progress 1

Note: i) Space is given below each question for your answer.

ii) Check your answer(s) with those given at the end of the unit. 1) Explain with example what is natural monopoly.

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2) Do you think that productivity of physical capital is improved by transportation?

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3) Identify the two major problems faced by Indian Railways.

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4) What is the underlying meaning of ‘Infrastructure’?

i) Underlying Foundation

ii) Factors of Production

iii) Private Sector

iv) Public Sector

13.5.1.3 Seaports and Airports

Seaports

India has 12 major ports and about 185 minor ports over its coastline spread over 7,000 kms. Major ports are managed by the Central Government and account for over 75 per cent of total cargo. Minor ports are managed by the State governments and account for the residual 25 per cent of cargo transportation. After the 1991 economic liberalisation, on an average, the sector realised a growth rate of 6.22 per cent.

A number of changes are taking place in the ports sector. After economic liberalisation, private investment is encouraged in this sector. This typically takes the form of private parties setting up terminals at existing ports. Such terminals have come up at Marmugao (JLNPT) and at Tuticorin and a new one is coming up at Kochi. Foreign collaborators have shown interest in setting up these terminals and the Australian P&O and the Port Authority of Singapore are among the investors already present.

Growth rate of traffic handled by major ports has accelerated in recent years, partly because of booming exports and partly owing to the new investments and consequent better efficiencies. Despite this, the volumes of cargo handled by India’s biggest ports are small in comparison with international ports like Singapore, Hong Kong and Rotterdam.

Ports require good inland connectivity. The efficiency of the roads and railways, which provide the connectivity, is, thus, an important factor in

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Infrastructureefficient port operations. Good connectivity and automated handling of cargo and factors that reduce the ship turnaround time and, thus, facilitate larger volumes of traffic. Government is investing in improving the road connectivity to major ports through the NHDP.

With private players coming in, it was necessary to provide for independent regulation so that a level playing field is provided to all operators. Accordingly, the Tariff Authority for Major Ports (TAMP) has been set up.

Better internal management can also provide for increased port revenues. Several foreign ports are organised as ‘landlord’ ports where the handling of cargo proper is awarded to private parties. In India, all major Ports are run by Port Trusts constituted by the Central Government, and the concept of ‘landlord’ ports has not yet been attempted. They function mainly as ‘service’ ports.

In the ‘minor’ ports segment also, new developments are taking place, especially on the initiatives of State governments of Andhra Pradesh and Gujarat. A wholly private owned port of Pipavav has come up in Gujarat and Railways, in collaboration with the port and the State Government have provided improved rail linkage to this port which is fully operational. Connected to the new oil refinery set up by the Reliance Group at Jamnagar, the port of Sika also in Gujarat now accounts for the largest cargo handling among all ports in the country. Table 13.1 contains the information.

Table 13.1: Traffic Handled at Major and Minor Ports ('000 Tons)

Major Ports Minor Ports Year POL Non-POL Total Container Bulk 1980-81 33578 46692 80270 1880 6730 1990-91 64004 87661 151665 7695 12780 1995-96 90923 124285 215208 18503 25710 2000-01 107423 173708 281131 32326 87210

POL stands for Petroleum Oil and Lubricants.

Airports

Mumbai and Delhi account for the largest share of all air traffic (domestic plus international) in India.

Airports are under the management of Airports Authority of India. Private investments are to be drafted for the upgradation of the four major airports (Delhi – Mumbai – Kolkata and Chennai).

New ‘greenfield’ airports under private ownership are coming up at Bangalore and Hyderabad.

A new airport promoted by Kerala State Government has come up in Kochi with private investor participation.

There is large scope for expanding airport traffic, especially on the cargo side. This requires modern handling facilities and adequate infrastructure. Passenger traffic is also increasing rapidly with recent changes in policies relating to ‘Inland travel tax’ and duties and taxes levied on aviation fuel. A new policy framework that permits private airlines to operate international


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routes (quotas for which are set through bilateral agreements between the two countries) is expected to contribute to increased competition and lower fares and consequently larger passenger volumes. Table 13.2 contains performance statistics of airports.

Table 13.2: Traffic Handled at Airports

Domestic Airports International Airports Year Aircraft

Movement Total No. of Passengers

Freight (Tons)

Mail (Tons)

Aircraft Movement

Total No. of Passengers

Freight (Tons)

Mail (Tons)

1980-81 235117 3619752 26077 6957 112116 9505749 195588 32460 1990-91 NA NA NA NA 142040 17177888 387775 25946 1995-96 158905 9783518 57453 10790 233630 24836478 561582 30885 2000-01 230754 13042073 140639 11027 262758 27917096 708614 35539 2001-02 246717 12727123 146008 11069 277275 26404360 700218 36564 2002-03 147939 6661302 40743 4618 418039 36649040 940897 43265

Roads and Railways along with Airports and Seaport infrastructure are treated as components of Multi-modal Transportation infrastructure. An integrated framework for the development of each of these components of logistics chain in conjunction is required in order to optimise the role of transport infrastructure in the development of the country.

13.5.2 Energy Infrastructure

Electricity is one of the main determinants of the quality of life. In India, the power sector has not kept pace with the growth in demand resulting in serious energy shortages. About 70 per cent of the rural households are yet to get electricity connections and power-based economic activities in the electrified villages are minimal. Out of the estimated 80,000 villages yet to be electrified, the Tenth Plan proposes to electrify 62,000 villages through grid supply. The balance 18,000 remote villages are proposed to be electrified by 2011-12 through the use of decentralised non-conventional sources of energy.

Uneconomic tariffs charged from the priority sectors, lower slabs of domestic consumption, high transmission and distribution losses (T&D losses), which often disguise large-scale theft, and low billing and collection efficiency are the important problems affecting the performance of electricity sector in India. Among all these problems, T&D loss is the major one, which is directly related to the functioning of the sector. The reported all-India average T&D loss increased from 19.8 per cent in 1992-93 to 26.45 per cent in 1998-99 and is estimated to have increased to 27.8 per cent by 2002. The high T&D losses are attributed to:

a) Weak and inadequate sub-transmission and distribution systems that are built to meet the haphazard growth of demand and to fulfill the short-term objective of extension of power supply to new areas;

b) Long transmission and distribution lines and inappropriate size of conductors;

c) Improper load management, resulting in overloading of systems; d) Pilferage and theft of energy and un-metered supply; and e) Financial constraints to undertake systems improvement schemes.

Power sector reforms were initiated in 1991 but given momentum in the present decade with the setting up of an independent and transparent

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Infrastructureregulatory regime. Private sector participation has also been set in motion with the enactment of the Electricity Laws (Amendment) Act in 1998. Further, major reforms aimed at promoting competition in generation, transmission and distribution of electricity have been enacted through the Central Electricity Act, 2003.

13.5.3 Communications

Noting the importance of improved communications in increasing productivity and welfare, the New Telecom Policy (NTP) was introduced in 1999. NTP 99 was aimed at accelerating further development in the provision of telecom services with increased private participation. The key objectives of the policy are:

• Availability of telecommunications at affordable price for achieving socio-economic goals of the country.

• Providing universal service to all uncovered areas including rural areas and remote, hilly and tribal areas.

• Providing greater competitive environment in both urban and rural areas. • Providing equal opportunities and level playing field for all players.

Provision of universal access to Basic Telecommunication Services at affordable prices and a greater role for the private capital is the motive of the NTP 99. Realising that universal service obligations cannot be fulfilled under normal commercial environment, the NTP (1999) for this purpose envisages raising of resources through imposition of a universal access levy, which is a percentage of the revenue earned by the operators under various licenses. The universal access levy, which supports the provision of village public telephones and rural direct exchange lines would cover both capital and recurring expenses to run the services.

Universal service is taken to mean nation-wide coverage, non-discriminatory access and widespread affordability of telecommunication services. Availability implies provision of telephone services in all areas, even if they are uneconomic, rural and remote. Accessibility implies uniformity, non-discriminatory in terms of price service and quality regardless of geographical location. Affordability principle holds that price should be affordable. In uneconomic areas, this may mean tariff such as rentals below cost.

The strategies envisaged in the NTP-99 have resulted in remarkable gains in spreading the telephones in the country. Table 13.3 presents the basic numbers reflecting the growth in telephone ownership since NTP 99.

Table 13.3: Performance Indicators of the Indian Telecom Services Industry

Indicators FE 2000 FE 2005 1) Subscriber Base (in millions) i) Fixed 26.65 45.9 ii) Mobile 1.90 52.17 Gross Total 28.55 98.08 2) Teledensity (percentage) i) Fixed 2.62 4.25 ii) Mobile 0.19 4.83 Gross Total 2.81 9.08

Note: FE, QE stand for financial year. Source: TRAI, The Indian Telecom Services Performance Indicators.


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In statistical terms, overall teledensity tripled in less than five years and reached 9.08 by the end of March 2005 by which point mobile telephone subscription had surged past conventional fixed lines. But because of duplication of ownership of telephones (same subscriber owning fixed and mobile) the statistical increase exaggerates the ground reality. Also, in terms of urban vs. rural, the subscriber growth is heavily skewed, as mobile technology is largely restricted to the urban areas. It is estimated that average teledensity in urban areas is now over 20 per hundred while it is only around 2 in the rural India.

A few key factors account for the increasing popularity of cellular technologies and the urban bias to its rapid growth. High costs of access loops of traditional wireline technologies paved the way for the use of mobile and limited mobile technologies. Because of the concentration of population, urban areas hold out potential for much larger subscriber numbers per unit of investment. Higher average incomes also ensure higher usage levels by individual subscribers. By comparison, usage levels in rural areas are unremunerative. Besides this, the flexible form of the communication also contributed to the popularity of mobile technology.

The USO policy meant for spreading telephones in rural areas has been operational for close to three years now. Over this period, it could complete the task of providing public communication facilities: the backlog of over 2,00,000 ‘unconnected’ villages (as of June 2002) has been almost wiped out and faulty technologies are being replaced. The major USO service that can result in growth in rural teledensity is the subsidising of private phones (DELs) in identified un-remunerative areas. The USO Fund Administration has just finalised the bids for implementing this part of the overall scheme. The implementation of this service would contribute towards an increase in rural teledensity. But to achieve the target of NTP 99, other policy supports that would harness mobile technology towards this purpose seem to be necessary.

In order to address these issues, the USO Fund has mooted a strategy of providing the backbone infrastructure in the rural areas having low teledensity. This strategy coupled with the subsidising of Rural Household DELs (private telephones) provided in identified high cost service areas (where revenues are not adequate to cover costs) and the introduction of Rural Service Providers or Niche Operators – an idea held out by TRAI – could bring about a breakthrough in growth of rural teledensity. The details of the three concepts – one of which has been operationalised – are as follows:

i) Subsidising the Rural Household DELs

The USO Fund invited tenders for installation, operation and maintenance of rural household DELs (RDELs) in 1685 ‘Short Distance Charging Areas’ (SDCAs, the basic Service area unit, generally approximating to a ‘taluka’) identified as net cost positive out of total of 2,648 SDCAs in the country. The participation of 7 Service Providers in the tendering process led to keen competition amongst the bidders for all Service Areas barring those in J&K, North East and Assam. It is a measure of the success of this strategy that the private operators M/s RIL won the bids for 205 SDCAs and M/s Tata Teleservices Ltd, for 213 SDCAs. This would mark the first major entry of private players into the rural segment.

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Infrastructureii) Creating Mobile Telephone Infrastructure

The second concept of subsidising the telecom infrastructure required for providing services in rural and remote areas is designed to facilitate the more suited mobile services in this segment. For this purpose, ‘purely passive items’ like towers and land, which are shareable between the operators, are considered for subsidy entitlement. These are to be provided exclusively in areas where there is no coverage of the cellular signal at present. The operator who provides the infrastructure will have exclusivity rights for one year after which the facilities would be shared with other operators by charging nominal rent in order to meet the maintenance costs of the towers.

Experience in other developing countries (Bangladesh, some African countries) points to successful adaptation of mobile technology for rural use. In Bangladesh, for example, mobile telephones have proved highly remunerative in rural areas by devising ways for shared usage. The concept mooted by the USO Fund is an attempt at finding solutions suited to Indian needs. Its implementation will require a suitable amendment to the Indian Telegraph Act for enabling provision of Cellular Mobile Services under USO Fund. Also the legal and technical issues involved in sharing the infrastructure need to be addressed.

iii) Niche Operators

It is assessed by TRAI that despite the USO support, existing big service providers would not be interested to serve about 50 per cent of the villages. To address this issue, TRAI in its Unified Licensing recommendations envisaged that the Short Distance Charging Areas with teledensity less than 1 per cent be notified as telecom-wise-backward areas. In these areas, niche operators, defined as ‘the telecom service providers whose services are restricted to these backward areas only’ will be inducted. These operators are entitled for concessions of zero entry fees, lower license fees and eligibility for USO support. The scheme is aimed to promote local entrepreneurs who have the technical competence to provide communication solutions but cannot compete on equal footing with large operators.

About the role of private capital in accelerating the rural teledensity growth, the financial and operational problems that inhibit private operators’ entry into rural areas need to be overcome. The recent policy change to raise the FDI limit in telecom is of limited value in this context because additional capital will again target the remunerative urban areas. Thus, despite its suitability, the spread of mobile telephones in rural areas so far has been very limited.

13.5.4 Banking Infrastructure An efficient financial system can influence the long-term growth through three important channels, namely: 1) increase in the proportion of saving transferred to investment spending, 2) augmenting private saving rate, and 3) improvement in the social marginal productivity. The financial intermediaries stimulate economic growth in two ways: (i) by channeling the individual saving into productive areas of development and (ii) by allowing the individuals to reduce risk associated with their liquidity needs.

The creation of specialised financial institutions assumes significance in this regard because supply of credit to the poor involves high risk and carries exorbitant interest rates. The task of the special financial institutions would be


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to identify impediments to enhancing the productivity of existing assets and to find ways and means to overcome these and simultaneously to promote viable economic activities for the rural poor.

13.6 GROWTH RATES OF THE ECONOMIC INFRASTRUCTURE

Table 13.4 provides growth rates registered by different economic infrastructure since 2000. With regard to the electricity sector, electricity generation through hydel projects experienced negative growth rate in the first three years. Similarly crude oil production in 2002-03, and all components of civil aviation sector saving export cargo experienced negative growth in 2002-03, showing the impact of wide spread recession in the country in that year. Among all the economic infrastructure sectors, telecommunications registered stable and higher growth over these five years revealing the success of reforms undertaken in this sector.

Table 13.4: Trends in Growth Rates of Economic Infrastructure Sectors (in percent)

Items Unit 2000-01 2001-02 2002-03 2003-04 2004-05 I. Energy 1. Electricity Generated (Utilities Only)

Bn. Kwh 3.9 3.1 3.2 5.0 6.5

a. Hydel " -7.6 -0.7 -13.7 15.6 17.6 b. Thermal (Incl. Nuclear) " 7.4 2.5 6.2 3.5 4.7 2. Petroleum a. Crude Oil Production Mn Tons. 1.5 -1.2 3.2 1.0 2.9 b. Refinery Throughout " 20.3 3.7 4.9 8.2 6.7 II. Transport and Communications 1. Railways Revenue Earning Good Traffic

" 3.7 4.0 5.3 7.5 7.7

2. Cargo Handled at Major Ports

" 3.4 2.3 9.0 9.9 11.1

3. Telecommunitions- New Telephone Connections Provided (Direct Exchange Lines)

‘000Nos 27.2 23.9 21.5 40.1 21.4

4. Civil Aviation a. Export Cargo Handled ‘000 tons. 5.1 4.1 13.3 1.0 11.8 b. Import Cargo Handled " 3.6 -1.0 18.6 13.8 30.1 c. Passengers Handled at International Terminals

Million 4.6 -5.0 4.8 6.5 15.7

d. Passengers Handled at Domestic Terminals

" 7.7 -5.7 9.6 13.1 25.9

Source: Annual Reports of Different Ministries, Government of India.

13.7 INTER-STATE DISPARITIES IN INFRASTRUCTURE STOCKS

In India, considerable inter-state disparities of infrastructure stocks are present. These are presented in Table 13.5.

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InfrastructureAs can be seen from Table 13.5, as for the electricity access, the 2001 Census found that in Bihar only 10 per cent of households have access to electricity. In the states of Jharkhand, Orissa, Assam, Uttar Pradesh and West Bengal states, power is accessible only to about one third or less number of total households. Punjab, Delhi, Himachal Pradesh and Goa states are better placed in terms of electricity accessibility. As for the number of households having telephone connections, Bihar, Jharkhand, and Chhattisgarh are placed much below the national average, while Delhi, Chandigarh, Goa and Union territory of Lakshyadweep figure much above the national average. Similarly, large gaps exist in households availing banking facilities. The states of Goa, Himachal Pradesh, Chandigarh, and Uttaranchal have more number of households that are availing banking facilities; the opposite holds for North Eastern states and Bihar.

Table 13.5: Inter-State Disparities of Economic Infrastructure

State Percentage of

Households Having Access to Electricity

Percentage of Households

Having Telephones

Percentage of Households Availing

Banking Services Andaman & Nicobar 76.8 21.0 64.0 Andhra Pradesh 67.2 8.6 31.0 Arunachal Pradesh 54.7 9.2 37.3 Assam 24.9 4.3 20.5 Bihar 10.3 2.2 21.3 Chandigarh 96.8 32.1 64.9 Chhattisgarh 53.1 3.8 24.1 Dadra & Nagar Haveli 86.0 7.3 30.6 Daman & Diu 97.8 15.7 47.6 Delhi 92.9 34.7 51.0 Goa 93.6 29.1 72.8 Gujarat 80.4 12.5 37.8 Haryana 82.9 12.7 45.2 Himachal Pradesh 94.8 16.5 59.5 Jammu & Kashmir 80.6 6.8 36.5 Jharkhand 24.3 3.3 30.1 Karnataka 78.5 12.8 40.0 Kerala 70.2 19.1 51.1 Lakshyadweep 99.7 60.6 51.7 Madhya Pradesh 70.0 6.2 27.9 Maharashtra 77.5 14.1 48.1 Manipur 60.0 5.3 8.7 Meghalaya 42.7 6.0 20.8 Mizoram 69.6 14.1 31.8 Nagaland 63.6 5.2 15.9 Orissa 26.9 3.9 24.2 Pondicherry 87.8 19.1 31.7 Punjab 91.9 18.9 48.5 Rajasthan 54.7 8.0 28.9 Sikkim 77.8 13.2 29.7 Tamil Nadu 78.2 11.2 22.8 Tripura 41.8 5.2 26.5 Uttar Pradesh 31.9 5.6 44.1 Uttaranchal 60.3 9.9 59.8 West Bengal 37.5 6.7 36.8 All India 55.8 9.1 35.5 Source: Census of India 2001.


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Considerable variations across states can be noticed from Table 13.5 with regard to infrastructure development. These differences are not only persisting but also widening despite the objective of balanced regional development of the Country. Factors that are responsible for the existence of such wide variation across States in India are as follows.

In India, State governments play a major role in developing infrastructure needed for accelerating growth. Many of the critical development subjects are allocated to the States, by the Constitution. National plans are prepared for the country as a whole and do not specify state specific growth targets. National plans expected that inter-state differences would narrow if resources are allocated based on the balanced regional development objective. The increasing share of revenue expenditure is curtailing State plan expenditure and states are resorting to larger volumes of borrowing to finance plan expenditure, which, in turn, is resulting in growing interest payment obligations. After meeting the revenue expenditure and interest obligations very limited funds are available for investment. Besides this, only some States are better focused on infrastructure development and able to create a policy environment, which is conducive for developing infrastructure by using private investments.

In this context, some are of the view that the objective of balanced regional development should not be overstressed if it seeks to achieve equality through a process of ‘levelling down’ by preventing states from reaching their full growth potential. On the contrary, well-managed states must be encouraged to reach their full growth potential and the lessons learnt from their superior performance could then be used as a model for other state to emulate.

Check Your Progress 2 Note: i) Space is given below each question for your answer.

ii) Check your answer(s) with those given at the end of the unit.

1) What is multi-model transportation infrastructure?

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2) Identify the key factors that account for increasing popularity of cellular technology.

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Infrastructure3) Name the states which have accessibility to electricity above the national average.

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13.8 COMPONENTS OF SOCIAL INFRASTRUCTURE IN INDIA

We can identify three distinct components of social infrastructure, viz., Health, Education and Other Areas, which facilitate the other components of the social sector to be used effectively for the benefit of the society. Special emphasis is given to health and education as these components directly help to build up human capital and enhance human capabilities to enjoy a higher standard of living. Let us now discuss these components in details.

13.8.1 Health

Health is one of the two key determinants of the Human Development Index (HDI) in addition to income and knowledge. The capability to lead a long and healthy life is considered as one of the three essential elements of enlargement of people’s choices at all levels of economic development. The required infrastructure for health care created in terms of hospitals, dispensaries and health centers etc., and formation of human capital in the form of doctors, nurses and others are observed from the Table 13.6 below.

Table 13.6: Health Care Infrastructure Development Since 1951

1951 2002 Sub Centres/Primary Health Centers etc. 725 1,63,196 Hospitals and Dispensaries 9,209 38,031 Beds (Private and Public) 1,17,198 9,14,543 Doctors (Modern System) 61,800 6,25,131* Nursing Personnel 18,054 8,36,000*

* Pertains to 2004.

With this, we can also add the infrastructure of Indian medicine system consisting of ayurveda, unani, siddha and homeopathy. In 2001, under this category, there were a total of 3,841 hospitals, 65,753 beds, 23,597 dispensaries, 6,88,802 registered practitioners and 9,832 licensed pharmacies with 88 PG and 412 UG colleges with admission capacity.

It may be mentioned that the social sector programmes in general and health care in particular fall largely under the jurisdiction of the State governments. The Central Government, however, supplements the States’ efforts by making additional resources available for specific programmes through Centrally Sponsored Schemes, Additional Central Assistance and Special Central Assistance. Currently the Common Minimum Programme (CMP) of the Central Government envisages raising public spending on health to at least 2-3 per cent of GDP with focus on primary health care. Special attention will


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be paid to poorer sections in the matter of health care. The basic objective of achieving an acceptable standard of good health amongst the general population of the country as set out in the National Health Policy 2002 and reiterated in the CMP continues to be the focus. Improvement in the general levels of health through larger allocations and more effective implementation of communicable and non-communicable disease programmes, changes in the pattern of assistance and implementation, and greater focus on tertiary health care have received special emphasis.

The Plan outlay for the Central Health Sector Schemes during 2004-05 was pegged at Rs. 2,208 crores. The Budget estimate for Central Government expenditure (plan and non-plan) on health and family welfare was Rs. 7,680 crores. The combined expenditure of Centre and the States on health in the same year was 40,352 crores. This amount was 4.4 per cent of the total expenditure and 23 per cent of the expenditure on social services. Special stress is given on the control/elimination of diseases like malaria, T.B., filaria, leprosy and HIV/AIDS.

The focus of the health sector programmes so far has been largely on control of communicable diseases. Some programmes for non-communicable diseases such as blindness, iodine deficiency, and cancer are also under implementation. There is a new initiative called National Mental Health Programme during the 10th Plan with an outlay of Rs. 130 crores. Since November 2004, there is another new scheme called Integrated Disease Surveillance Project with a proposed outlay of Rs. 88 crores for 2005-06. Emphasis is placed in the 10th Plan to utilise effectively the traditional Indian medicine system consisting of ayurveda, yoga, unani and siddha. These combined with homeopathy is named as AYUSH and the Plan allocation for its development is Rs. 775 crores.

One important component of the health sector is the family welfare programme with a long-term objective to achieve population stabilisation by 2045. India accounts for one-sixth of humanity with the risk of achieving the dubious distinction of becoming the most populous country in the world by about 2050. The population (2001) of 1,027 million needs to be controlled effectively. However, the last two decades have witnessed improvement in all the important health indicators. The 10th Plan targeted a reduction in the decadal growth rate of the population to 16.2 per cent. The Plan outlay for the family welfare has been Rs. 27,125 crores. The expenditure in the health sector is proposed to increase from 0.9 per cent of the GDP to 2-3 per cent in this period. To augment health care services in the rural areas, a National Rural Health Mission has been conceptualised. The existing schemes of Reproductive and Child Health Programme, the Mother NGO programme and others are also being continued. In this connection, it may be mentioned that the 10th Plan envisages provision of safe drinking water to all rural inhabitants in its efforts to supplement the activities of the states by providing financial and technical support. There is also the Accelerated Urban Water Supply Programme for providing water supply to the smaller towns. Another health related project, the Total Sanitation Campaign has now covered 426 districts in the country with an outlay of Rs. 4,136 crore.

13.8.2 Education

Education is the other important component of the social infrastructure where also India has a long way to go considering the current level of various

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Infrastructureeducational indicators. Of course, it is true that her literacy rate has gone up from only 18.33 per cent in 1951 to 64.84 per cent in 2001, yet it is also true that this rate of growth is extremely slow and India could not achieve full literacy even after more than 55 years of independence. This also means that India has the dubious distinction of having the largest number of illiterates in the world. This becomes clear when we find that India’s Adult and Youth literacy rates are 61.3 and 73.3 respectively, while these rates for Sri Lanka are as high as 92.1 and 97.0 respectively.

In the education sector, the most important physical infrastructure is educational institutions. During 2002-03, the total number of recognised educational institutions in India is as follows:

Primary/Junior Basic School---651382, Middle/Senior Basic School----245274

High Sch/HS/Inter/Jr,College--137207, Colleges for Gen. Edu.-------------9165

Professional Education------------2610, Universities/Deemed Univ.*--------385

* Includes Inst. of National Importance and Research Institutes.

However, these figures do not take into account the rapidly increasing private sector educational institutions at all levels.

So far as the human component of educational infrastructure is concerned, the number of teachers at the elementary level was 3.5 million in 2002-03, of which the share of female teachers was 40 per cent. The Pupil-Teacher Ratio in the primary and upper primary levels is 42.1 and 34.1 respectively which, however, have remained more or less constant over the decades despite the increase in the number of teachers in this period.

The broad policy framework for the development of education and eradication of illiteracy contained in the National Policy of Education, 1986, has set a goal of expenditure on education as 6 per cent of the GDP. However, the combined total expenditure on education by Central and State governments was only 3.74 per cent of GDP in 2003-03 (BE). A high priority has been accorded to this sector in the 10th Plan, with an allocation of Rs. 43,825 crore as against Rs. 24,908 crore in the 9th Plan, representing an increase of 76 per cent. The Central Government expenditure on education, sports and youth affairs in 2004-05 (BE) is Rs. 12,091 crore, while the combined expenditure of all Governments in the same year on education is Rs. 85,358 crore. This amount is 9.4 per cent of the total expenditure and 48.8 per cent of expenditure on social services.

Among the current on-going and new programmes, mention may be made about the Sarva Shiksha Abhiyan, which is being implemented in partnership with the states. It addresses the needs of 192 million children in 11 lakh habitations. 8.5 lakh existing primary and upper primary schools and 33 lakh existing teachers are covered under this scheme and an allocation of Rs. 3,057 crore has been made in 2004-05 (BE). A new scheme ‘National Programme for Education of Girls at Elementary Level’ is implemented in educationally backward blocks where the level of female literacy is below and the gender gap is above, the national average and in some other select areas. A new scheme called Kasturba Gandhi Balika Vidyalaya has been approved in 2004-05 for girl students belonging to the weaker sections living in difficult areas. In the same year, an educational cess of 2 per cent on all central taxes has


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been imposed to create a separate fund for the schemes of basic education and the mid-day meal scheme. The growth in the area of higher education continued with a student enrolment of 9.51 million in 2003-04. There has also been a significant increase in the enrolment under open and distance education system.

13.8.3 Other Areas Among the other areas where social infrastructure is important, mention may be made about the matters which are not included in the construction of the Human Development Index, and the related issues, though their importance in the provision of social infrastructure cannot be denied and neglected. These include measures to improve women’s empowerment, social harmony and peace, removal of social vices like untouchability, communalism, child marriage and dowry, adulteration of food and malnutrition etc. Besides, there are also the problems of empowerment of the socially disadvantaged (which includes persons belonging to the scheduled castes, religious and social minorities, socially and educationally backward classes), welfare of persons with disabilities and programmes of social defence relating to the victims of alcoholism, drug addiction, juvenile social maladjustment, welfare of prisoners, children in need of care and protection, welfare of aged and matters relating to the administration of Wakf. The Ministry of Social Justice and Empowerment deals with these matters. However, though many legal provisions exist in India to fulfill these objectives, yet their successful implementation largely depends on the social awareness of the people at large.

13.9 ASSESSMENT OF SOCIAL INFRASTRUCTURE PERFORMANCE

In terms of the HDI, India currently belongs to the category of medium human development group of countries. Health and education, the two most important components of the HDI, though have experienced considerable progress since independence, yet the very slow rate of growth in these areas could not reduce the gap between India and other high income industrialised economies. While from the beginning of the planning period, the Government has adopted various measures to build up the social infrastructure in the economy and followed a strategy to proceed towards a socialistic pattern of society, in terms of performance, it was well below the people’s aspirations. One of the reasons of this unsatisfactory performance is the prevalence of leakages in the implementation process due to widespread corruption at all levels. Besides, the social sector in India has always received a low official priority. In case of any financial stringency, the first casualty has always been the allocation for the social sector. This is also reflected in the relative lack of adequate data for the different components of it. Moreover, the official strategies adopted for the development of social infrastructure have followed largely a top-down approach, thus, bypassing the voluntary participation and opinion of the common people. After the initiation of economic reforms in 1991, though the participation of the private sector in the provision of social infrastructure has gone up, yet in many cases they could not fulfill the needs of the people as they are guided by purely profit motives. In fact, in the opinion of Prof. Amartya Sen, specially in the areas of health, education and social security, state participation and intervention are necessary.

Coming to component-wise performance of social infrastructure, it may be noted that the allocation of fund in education has always fallen short of the

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Infrastructurenorm fixed by the authorities themselves. Even when the finance is not a problem, the question of quality is not emphasised. As a consequence, our human capital could not acquire the required skill and resulted in low productivity compared to many developed countries. The pattern of education in India has always been elitist in nature leading to neglect of primary education. In case of higher education also, standard of education widely varied among institutions and most of the students passing out from institutions like IIT or IIM are catering to the markets of the western countries instead of serving their land. This skewed pattern of higher education has been accentuated under the new economic policy since 1990s.

Almost similar observations may be made for the performance of the other component of social infrastructure, viz., health. While it is an achievement to lower the high death rate through the provision of an expanding infrastructure for health care, it is also true that India’s performance in reducing the infant mortality rate is not satisfactory. At the same time, her inability to reduce the high birth rate has created a situation when population appears to be a problem though she has been the pioneer in the adoption of family planning measures. The quality of service at the public hospitals/health centres has deteriorated over time and the private health care services are beyond the reach of the common people. Though it was believed that malaria has been eradicated from India, but now this menace has returned again. Gradually, diseases like TB and AIDS are assuming dangerous proportions. Inability to control adulteration of food items and prevalence of mass poverty have led to malnutrition which ultimately weakens the basis of the human capital leading to low productivity and low income. It is apprehended by many that after the passing of the new Patent Act under the WTO regime, the prices of medicines in general will rise sharply, leading to further deterioration of the health situation.

Among other areas of the social infrastructure mentioned above, it may be said that while financial allocations have been made and progress has definitely taken place in different areas, but these maladies still persist in different parts of the country in varying degrees. Real happiness and prosperity of any society actually depends on successful achievements in these fronts.

13.10 POLICIES FOR SOCIAL INFRASTRUCTURE DEVELOPMENT

The origin of official policies for social infrastructure development is the National Policy of Education, 1986 for the development of education and eradication of illiteracy and the National Health Policy, 2002 for achieving an acceptable standard of good health among the general population of the country. Currently, the present Government is formulating their strategies on the basis of the CMP or Common Minimum Programme, which has emphasised the social sector development. Expenditure on the various components of these sectors have also increased substantially in recent years. It has been mentioned in the Economic Survey 2004-05 that higher levels of expenditure on the social sectors could be sustained through reprioritisation of expenditure both by the States and the Centre. It has been further admitted that availability of resources alone cannot guarantee social sector development and the efficacy of a large number of official programmes would have to be vastly improved through various measures. An efficient management and improved


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delivery system for these programmes are essential to effectively implement the social sector programmes through the decentralised system of Panchayati Raj Institutions with full and voluntary participation of the people. This would also ensure transparency in implementation, which would effectively check leakages in these programmes.

13.11 IMPLEMENTATION ISSUES

Infrastructure sector, especially economic infrastructure, projects are facing a variety of problems, which are to be addressed in order to realise the full advantage of infrastructure investments in the country. These are:

a) Cost and Time Overruns: Cost and time overruns of infrastructure projects in general and projects managed by public sector enterprises in particular, still remain at very high levels. These arise due to the delays in obtaining clearances like environmental clearances from the concerned Government bodies, land acquisition problems, financing problems and problems arising due to the poor management practices of the agencies involved.

b) Huge Inter-State Variations: Considerable inter-state variations of infrastructure development exist in the country. This is owing to the situation of State governments having major role in developing economic infrastructure. Many of the critical development subjects are added to the ‘State’ list. In India, National Plans are prepared for the country as whole and do not specify state specific growth targets. Some states, owing to their increasing revenue expenditure and inefficient economic management are not able to develop the requisite infrastructure.

c) Cross Subsidisation: Cross subsidisation practices followed in different infrastructure segments like railways, telephones, and electricity, though they have been reduced drastically in sectors where agencies are in position, still call for major tariff rebalancing exercise.

d) Regulatory Mechanism: In the liberlised policy environment, designing suitable regulatory environment, which prohibits the exploitation of natural monopoly nature of infrastructure services by the private operators is necessary. Designing, an efficient regulatory system, specifying their scope, roles and responsibilities, has become a major problem associated with the development of infrastructure sectors.

e) Huge Project Risks: Private investments are not forthcoming as the private operators are deterred by the huge risks and low returns in the initial years associated with infrastructure projects. Availability of long tenor loans and risk insurance policies need to be designed.

f) Policy on Private Participation: Suitable sector specific policies for private investments in the identified aspects need to be put in place.




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Infrastructure1) What are the major components of the social infrastructure? Discuss the importance of health in this context to form human capital in India?

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2) Why education is important for human development?

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13.12 LET US SUM UP

Infrastructure refers to the physical framework of facilities through which goods and services are provided to the public. It is of two types: economic infrastructure and social infrastructure. Economic infrastructure comprises of sectors that have capital investments on hardware as a significant component. Social infrastructure mainly refers to infrastructure in the form of health and education facilities. Economic development is meaningful only when it leads to educational and health upliftment of the people. For this purpose, it is necessary to strengthen the human capital base of the economy.

During the last five years, electricity generation has witnessed negative growth rate in the first three years. Crude oil production and all components of civil aviation have also experienced negative growth in 2002-03. However, telecommunications have illustrated stable and higher growth over the five years.

Two major components of human capital formation are education and health. India though belongs to the category of middle human development countries, yet her progress in terms of these two indicators is quite slow. A number of official strategies have been implemented in India to build up social infrastructure in these two crucial areas, but due to leakages and lack of people’s participation, their performance have been far from satisfactory. The situation has become more vulnerable since the initiation of economic reforms in the 1990s, as the state is gradually withdrawing itself from social services and the private sector is expanding but working with profit motive only cannot do justice to the objectives of the social infrastructure.

Considerable inter-state variations are noticed in the infrastructural development in the country. Cost and time over-runs, huge inter-state variations, cross subsidisation, huge project risks, inefficient regulatory mechanism are the various issues and concerns encountered in the execution of infrastructure related projects.


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13.13 EXERCISES

1) What do you mean by infrastructure? Examine the importance of economic infrastructure in the process of growth.

2) Evaluate the growth of economic infrastructure in India. Has it been adequate to meet the growth requirements of the economy?

3) Account for the regional disparities in the growth of infrastructure stocks in the economy. How has it adversely affected the growth process?

4) Examine the different implementation issues involved in the development of the infrastructure sector in the Indian economy.

5) What do you mean by social infrastructure? What are its important components? Make an assessment of the growth of social infrastructure sector in the Indian economy.

6) Evaluate the policy towards development of social infrastructure sector in India.

13.14 KEY WORDS

Economies of Scale: A firm is said to experience economies of scale if its cost of producing a unit of output falls as it increases its output. There are internal economies, which result mainly from factors internal to the firm like optimal usage of fixed assets. Similarly, there are external economies of scale, which arise due to factors not specific to the firm but to the industry as a whole.

Amortisation: It is the provision for the repayment of debt by means of accumulating a reserve through regular payments equal to the estimated depreciation of the asset.

Cross-subsidisation: Financing a loss-making business activity with profits made in a profit making activity. In the case of economic infrastructure, in order to meet the policy targets of the Government, rural infrastructure services are provided at subsidised prices and the resultant losses are covered by the profits generated from urban infrastructure services.

Greenfield Investment: Entering a foreign market by setting up an entirely new business establishment by the foreign investor is called ‘Greenfield Investment’. On the other hand, entering foreign market by acquiring an existing firm is called ‘brown field investment’.

Universal Service Obligations: Making some identified service(s) available to customers on a widespread basis even though they are not commercially viable. Providing subsidies for creating and maintaining infrastructure facilities like telecommunications in rural and remote areas has been undertaken in order to fulfilling ‘Universal Service Obligations’ in India.

Social Infrastructure: Refers to infrastructure mainly in the form of health facilities like hospitals, dispensaries, health centers, etc., and educational facilities such as schools, colleges and universities, etc.

HDI: Human Development Index. A measure lying between 0 and 1 indicating the level of human development enjoyed and constructed on the

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Infrastructurebasis of three indicators coveted by human beings, viz., healthy life, knowledge and a decent standard of living.

Infant Mortality Rate: Number of infants dying under one year of age in a year per 1000 live births in the same year.

Literacy Ratio: Number of literate persons, i.e., those with formal or non-formal education who, in the least, are able to ‘read and write with understanding in any language’, as a percentage of total population.

AYUSH: Includes Ayurveda, Yoga, Unani, Siddha, Homeopathy and Naturopathy, which may be loosely termed as the Indian Medicine System.

13.15 SOME USEFUL BOOKS

CMIE (2003); Infrastructure, Center for Monitoring Indian Economy, Mumbai.

Dutt, R. and Sundaram, K.P.M. (2004); Indian Economy, 50th Edition, S. Chand & Co, New Delhi.

Economic Survey (2004-05); Government of India, New Delhi.

Jimenez, E. (1995); Human and Physical Infrastructure: Investment and Pricing Policies, in Behrman, J. and Srinivasan, T.N. (eds.), Handbook of Development Economics, Chapter-43, Vol-3B, North-Holland.

Ministry of Finance (1996); The India Infrastructure Reports: Policy Imperatives for Growth and Welfare, Government of India.

Sen, Raj Kumar (ed) (2005); Social Sector Development in India, Deep & Deep Publications Pvt. Ltd, New Delhi.

Statistical Outline of India (2004-05); TATA Services Limited, Mumbai.

UNDP (2004); Human Development Report, Oxford University Press, New Delhi.

13.16 ANSWERS OR HINTS TO CHECK YOUR PROGRESS EXERCISES


1) Natural monopoly refers to a situation when a single firm produces the entire output enjoying economies of scale in process of producing good or a service. Indian Railway enjoys natural monopoly.

2) Yes.

3) Drop in its resources needed for development purposes, increased competitiveness from other modes of transportation.

4) i)


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1) See Sub-section 13.5.1.3 under sub head ‘Airports’.

2) High cost of traditional wireline technology.

3) Punjab, Delhi, Himachal Pradesh, Goa.


1) Study Sub-Sub-section 13.8.1 and attempt yourself. Also add inputs from Sections 13.9 and 13.10 to discuss official strategies and assessment.

2) Study Sub-Sub-section 13.8.2 and attempt yourself. Also add inputs from Sections 13.9 and 13.10 for elaborating official strategies and assessment.

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UNIT 14 INDIAN FINANCIAL SYSTEM: MONEY MARKET AND MONETARY POLICY

Structure

14.0 Objectives 14.1 Introduction 14.2 Money Market in India

14.2.1 Call/Notice/Term Money Market 14.2.2 Repos/Reverse Repos 14.2.3 Treasury Bills 14.2.4 Commercial Paper 14.2.5 Certificate of Deposits (CDs) 14.2.6 Bills Rediscounting 14.2.7 RBI’s Intervention in the Money Market

14.2.7.1 RBI’s Standing Facilities (Refinance) to Commercial Banks 14.2.7.2 Liquidity Adjustment Facility (LAF)

14.3 Monetary Policy in India 14.3.1 Objectives of Monetary Policy 14.3.2 Analytics of Monetary Policy 14.3.3 Operating Procedures: Instruments and Targets

14.3.3.1 Instruments of Monetary Policy 14.3.3.2 Operating Targets

14.3.4 Monetary Policy in the Early 1990’s 14.3.5 Monetary Policy in the Late-1990’s Onwards

14.4 Let Us Sum Up 14.5 Exercises 14.6 Key Words 14.7 Some Useful Books 14.8 Answers or Hints to Check Your Progress Exercises

14.0 OBJECTIVES The purpose of this unit is to develop among learners an understanding of the nature and role of the Indian money market, and how monetary policy is implemented by the Reserve Bank of India (RBI) in the country. After going through this unit, you will be able to:

• state the role of the money market; • describe the different components of the money market; • explain the mechanism of RBI intervention in the money market; • state the objectives of monetary policy in general, and in India in

particular; • identify the targets and operating targets of monetary policy in India; and • analyse the process and mechanism adopted by RBI in implementing

monetary policy in India.

14.1 INTRODUCTION This unit focuses on two inter-related aspects of the Indian financial system. First, it discusses the components and functions of the money market. Since


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money market is the focal point through which the central bank of the country (i.e., the Reserve Bank of India) executes the monetary policy, the nature of its intervention in the money market is also discussed. In view of the discussion of the role and functions of money market and the nature of RBI intervention in the money market, second part of the unit explains how monetary policy is implemented in India. In fact, in line with the financial sector reforms, this aspect has undergone substantial changes over the 1990’s. The changes in the structure and functioning of the money market have been brought about by the RBI in order to change the ways in which it conducts the monetary policy. The important changes in the money market and the corresponding changes in the way monetary policy is executed, have been discussed. However, the underlying objective has been to apprise you of the latest status of the money market and monetary policy.

14.2 MONEY MARKET IN INDIA In theoretical macroeconomics, the term “money market” refers to the market for financial assets. However, in the context of financial markets, money market refers to the market for short-term funds, i.e., up to one-year maturity. In brief, money market is the place where lending and borrowing is done through instruments having an original maturity of up to one year.

Interest rates in this market are indicators of short-term liquidity position in the financial system. From the point of view of monetary policy, the money market plays an extremely important role since RBI intervenes in this market to control the short-term liquidity positions and interest rates in the economy through this market. In view of the growing inter-linkages between the money market, dated Government securities market and foreign exchange market, the money market conditions affect the other two markets, especially the foreign exchange market. In short, the money market provides a mechanism to balance the demand for and supply of short-term funds. This market provides the opportunity to the eligible participants to invest their short-term surplus funds and to borrow short-term funds in case of deficit.

Money market consists of the call/notice/term money market, and a number of instruments like treasury bills, repos (and reverse repos), commercial papers, certificates of deposits, and bill rediscounting.

14.2.1 Call/ Notice/Term Money Market The call money market is the market for borrowing and lending for short-term periods (usually upto 14 days, but at times more than that) mostly by commercial banks. It is a telephonic market, i.e., deals are struck over telephone and reported to RBI. Commercial banks often face temporary shortages of funds (e.g., to meet CRR and SLR requirements, or sudden outgo of funds) or temporary surpluses. When a bank is in shortage of funds, it borrows from another bank which is in surplus. Deals in this market are struck over telephone.

If borrowing (or lending) is made for one day (overnight), it is known as “Call Money”. This segment is also called overnight money market. If the maturity of borrowing (or lending) is more than 1 day but up to 14 days, then it is known as “Notice Money”. “Term Money” refers to money borrowed (or lent) for more than 14 days but less than one year. In Indian money market, most of the transactions are of call money and notice money.

In this market, commercial banks and primary dealers can both borrow and lend, but financial institutions (LIC, UTI, GIC, IDBI, NABARD, ICICI) and

Indian Financial System:Money Market and

Monetary Policy

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mutual funds can only lend. RBI, as regulator, routinely participates in the market to inject liquidity (lend) or to mop up liquidity (borrow). As part of the financial sector reforms, RBI has been progressively moving towards making this market a purely inter-bank market (including the primary dealers) by gradually limiting the scope of participation of non-bank players.

14.2.2 Repos/Reverse Repos In a repo (also known as ready forward contract) transaction, one party borrows funds for a specific period (known as repo period) against the collateral of specific securities at pre-determined rate (known as repo rate). Although the primary objective is to borrow funds, the legal title of the security also changes. That is, the first party sells the security to the second party and agrees to purchase it back at a pre-determined price at a future date. Effectively, the first party (which sells the security) gets access to funds for the intervening period between the sale of the security and its repurchase, known as repo period.

Similarly, a party that needs to invest a temporary surplus cash, or needs to increase its holding of securities (e.g., banks requiring to meet SLR obligation), will enter into an opposite type of transaction with another party – it will buy the security and will agree to sell it back at a future date at a pre-determined price. This transaction is known as reverse repo transaction. In other words, from the point of view of the seller of the security, it is a repo transaction, and from the point of view of the buyer it is reverse repo transaction. A particular deal may be termed as repo or reverse repo depending on who initiated it. Essentially, repo is a means of borrowing against the collateral of the security that is sold now and bought back at a future date, and reverse repo means lending against the collateral of the security that is bought now and sold back at a future date.

In India, apart from the Reserve Bank, only scheduled commercial banks (excluding regional rural banks) and primary dealers can participate in repo/reverse repo transactions. Non-bank participants (e.g., financial institutions) can only lend money to the eligible participants (RBI, commercial banks, PDs) through reverse repo. In a move to broad base the repo market, companies listed on Indian stock exchanges have been allowed to lend their surplus cash in the repo market from April 2005. The securities eligible for repo/reverse repo transaction are specified as the Central and State Government securities including treasury bills.

For the purpose of absorption of short-term liquidity, RBI carries out overnight (one day) repo auction at a fixed rate. This means, RBI is ready to sell as much securities as is demanded by the participants at the fixed rate. This rate is fixed in the sense that it does not change on a daily basis depending upon the supply-demand condition of short-term liquidity, as would be the case for a variable rate repo auction. Changes in the fixed repo rate are usually made in the Annual Monetary and Credit Policy or in the Mid-Term Review of the Monetary and Credit Policy.

Repo auctions (multiple price auction, or variable rate repos) on Government securities were introduced in December 1992. Initially, repo auctions were conducted for tenors of 1 or 2 days that was later extended up to 14 days. Auctions were discontinued in early 1995 on the face of lack of market demand in view of the tight liquidity conditions. Repo auctions were re-introduced in early 1997 but this time with 3 to 4 day cycles. Fixed rate repos (uniform price auctions) with tenor of 3 to 4 days were introduced in


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November 1997. In recent past, RBI has conducted auctions of fixed rate repos with tenor of 7 and 14 days, as well as of variable rate overnight repos. With effect from November 1, 2004, auction of fixed-rate repos of 7 and 14 days tenor and variable rate overnight repos have been discontinued, although RBI reserves the right to use them at any point of time if the situation so warrants. Currently, fixed-rate repo and reverse repo auctions are conducted by the RBI on a daily basis (excluding Saturdays, Sundays and other public holidays) for 1 day (overnight) tenor.

In order to inject liquidity into the system, RBI conducts fixed rate auctions of reverse repo at a rate higher than the repo rate. The reverse repo rate is linked to the repo rate in the sense that it is set at specific percentage point above the repo rate. The fixed repo rate was increased from 4.50 per cent to 4.75 per cent and the spread between the repo rate and the reverse repo rate has been reduced to 125 basis points (100 basis point = 1 per cent) from 150 basis points with effect from October 27, 2004. In view of rising inflationary expectations, the fixed repo rate was further raised to 5 per cent effective from April 29, 2005. However, the reverse repo rate was unchanged at 6 per cent, so that the spread between the two rates currently stands at 100 basis points. Thus, in spite of the changes in the repo rate in last two years, the reverse repo rate has been kept equal to the bank rate which is currently set at 6.

The repo/reverse repo transactions that the RBI undertakes are primarily for the purpose of conducting monetary policy. The eligible participants can also engage into repo transactions among themselves at market-determined rates. However, in the presence of the fixed repo rate of the RBI, the market determined repo rate does not deviate much from the fixed rate.

It may be noted that the way the terms repo and reverse repo have been defined above, is just opposite to the international practice. That is, what is repo in Indian terminology is reverse repo in international parlance, and what is reverse repo in India is internationally known as repo. In a fast globalising environment, this may create confusion. Consequently, RBI has changed the definitions of repo and reverse repo to bring them in line with international practice with effect from 27th October 2004. However, in this unit, we have throughout followed the older (Indian) definition.

14.2.3 Treasury Bills

Treasury bills are short-term securities (up to 364 days) issued by the Central Government. Currently, treasury bills are issued with three maturities – 91 days, 182 days and 364 days. Being free of default risk, yields on the treasury bills serve as benchmarks for most other short-term rates. Treasury bills market is the place where Central banks in most countries prefer to intervene in treasury bills market for influencing liquidity and short-term interest rates. The development of this market is crucial for the conduct of open market operations.

Treasury bills are issued at a discount to the face value. For example, a 91-day treasury bill of face value Rs. 100 is issued at a price of Rs. 98.53. This means that the investor will pay Rs. 98.53 at the time of purchasing the bill, and will receive Rs. 100 on maturity after 91 days. The yield in this example is calculated as 5.9677 per cent [= {(100 – 98.53)/ 98.53} (364/91)]. The second term (364/91) annualises the yield. Note that the year is taken as consisting of 364 days. With effect from October 27, 2004, RBI has changed this convention and now the yield calculation is done on the basis of 1 year = 365 days.


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A system of auction of 91-day treasury bills and a vibrant market for this instrument existed before the 1960’s. Two events destroyed this market. First, the system of selling 91-day treasury bills through auctions was discontinued in the mid-1960’s and was replaced by on-tap 91-day treasury bills. This means that now the treasury bills would be sold throughout the week at a fixed interest rate instead of through auctions conducted on a weekly basis. The on tap bill rate used to change in line with the bank rate till 1974, since when the rate was kept unchanged at 4.6 per cent for years. On tap bills were sold to RBI as well as to other market participants. Second, in the mid-1950’s, a system of ad-hoc treasury bills was introduced. These bills were automatically issued (to RBI) as and when the cash balance of the Central Government with the RBI fell below a certain level. This system brought in an era of uncontrolled monetisation of the Central Government’s deficit. Market interest in the treasury bills revived once again with the introduction of 182-day treasury bills in November 1986 and establishment of Discount and Finance House of India (DFHI) in 1988 to provide a secondary market for treasury bills (and for a number of other money market instruments).

Reforms in the treasury bills market began with the introduction of 364-day treasury bills on fortnightly auction basis since April 1992. A system of auction of 91-day treasury bills was introduced in January 1993. The most important change came about when the Central Government and the RBI entered into an agreement to discontinue the ad-hoc treasury bills from April 1, 1997. Since that time (i.e., beginning in 1997-98), the automatic monetisation of fiscal deficit has been stopped and the Central Government has relied on market borrowing to finance the fiscal deficit. This move, apart from creating some independence for the monetary policy, has also given a big boost to the development of the debt market.

14-day treasury bills were introduced on June 6, 1997 and discontinued with effect from May 14, 2001. 182-day treasury bills were introduced in November 1986. Auctions of these treasury bills were not held between April 28, 1992 and May 25, 1999, and were discontinued with effect from May 14, 2001. These treasury bills were re-introduced in the first week of April 2005.

The investors in treasury bills include banks, primary dealers, financial institutions, provident funds, insurance companies, NBFCs, FIIs and State governments.

14.2.4 Commercial Paper Commercial papers (CPs) are short-term (up to 1 year) unsecured borrowing through issue of financial instruments (called commercial papers) by large, reputed and financially strong corporates enjoying high credit rating. Non-financial corporates (and primary dealers and All India Financial Institutions), having a specified amount of net worth (currently specified as Rs. 4 crore or more) and having a high credit rating (P2 or its equivalent) can issue commercial papers for any period between 7 days (brought down from 15 days with effect from 26th October 2004) to 1 year. Currently, CPs can be issued in denomination of Rs. 5 lakh and in multiples of Rs. 1 lakh thereafter. The investors in CPs include banks, financial institutions, mutual funds and high net worth individuals.

14.2.5 Certificate of Deposits (CDs) CDs are instruments of short-term borrowing by commercial banks. All scheduled commercial banks (excluding RRBs and cooperative banks) can


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issue CDs for a minimum period of 15 days and a maximum of 1 year in denominations of Rs. 5 lakh and in multiple of Rs. 1 lakh thereafter. All India Financial Institutions (AIFIs) can also issue CDs, but for maturity of 1 year to 3 years and, hence, CDs issued by the AIFIs cannot be considered as a money market instrument. The CDs are just like bank fixed deposits, but with the difference that the CDs are freely transferable by an endorsement (just like equity shares or bonds) while bank fixed deposits are not. Like treasury bills, CDs are also issued at a discount to the face value. The discount rate or the yield on CDs can be freely negotiated between the issuer and the investor. CDs can be issued to individuals, corporations, trusts, institutional investors, etc.

From the point of view of the issuing bank, CDs are rather high cost source of fund.

14.2.6 Bills Rediscounting A bill of exchange arises in respect of sale of goods when the buyer likes to make the payment sometime later (say, after he resells the goods) and the seller likes to receive the payment earlier than that. In this situation, the seller (or the drawer) draws (or makes) a bill of a given maturity on the buyer (the drawee) and sends it to the buyer. The buyer then endorses or accepts the bill, which means that he agrees to make the payment at or within a future date specified in the bill, and sends it back to the seller. The seller, who needs money as early as possible, presents this accepted bill to his bank, and gets a payment from the bank against this bill. The bank actually purchases the bill from the drawer (seller of goods) at a price slightly less than the amount represented in the bill (i.e., the amount that the buyer agrees to pay at a later date). This process is known as discounting of bills by the bank. The bank then collects the money as and when the drawee (the buyer of goods) makes the payment. The bank earns the difference between the purchase price (or the discount price) and the bill amount, which is also the cost to the drawer of the bill for getting the payment earlier than when the drawee (buyer) pays. Of course, the bank takes precautions so that the buyer’s payment is guaranteed (e.g., a security from the drawer or seller held as collateral, an arrangement with the buyer’s bank, etc.). Since the bills of exchange are negotiable instruments, the bank can sell the bills to another party (e.g., another bank). A bank can also place the bills discounted by itself with the central bank (i.e., the RBI) and get money for use in its lending activities (of course, at a certain rate of interest – usually the Bank Rate). This process is known as rediscounting of bills by the central bank.

Bills can be inland (when it is drawn and payable in India) or foreign (when it is drawn outside India and payable in or outside India). Bills can also be classified as demand bill (when the bill is payable by the drawee immediately on presentation before him) or usance bill or time bill (if the bill is payable at a future date).

In India, although banks regularly discount a large volume of bills, a secondary market for rediscounting these bills is lacking. Earlier the RBI used to provide rediscounting facility through its discount window, but the practice seems to have been discontinued from the early 1980’s.

14.2.7 RBI’s Intervention in the Money Market In order to control the liquidity position in the financial system, RBI regularly intervenes in the money market either to absorb liquidity when it is in excess


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or to inject liquidity when there is a shortage of liquidity. Two important ways in which the RBI intervenes in the money market are through its standing facilities or refinance and the Liquidity Adjustment Facility (LAF). An understanding of these aspects is absolutely necessary to understand the way monetary policy is conducted in India.

14.2.7.1 RBI’s Standing Facilities (Refinance) to Commercial Banks

The Central Bank, as a lender of last resort, provides liquidity to banks when the latter face shortage of liquidity. This facility is provided by the Central Bank through its discount window. Commercial banks can borrow from the discount window against the collateral of securities like commercial bills, Government securities, treasury bills, or other eligible papers. Some central banks even allow commercial banks to borrow from the discount window without any collateral. In India, this type of support of the Central Bank earlier took the form of refinance of loans given by commercial banks to various sectors (like exports, agriculture, etc.). Under this facility, commercial banks could borrow from the RBI certain percentage (specified by the RBI from time to time) of the loans given by them to the specified sectors. RBI used the sector-specific refinance facilities as an instrument of credit policy to encourage or discourage lending to particular sector by varying the terms and conditions of refinance. However, in line with the financial sector reforms, RBI has withdrawn from the direct and micro-management of credit. Accordingly, the system of sector-specific refinance schemes (except export credit refinance scheme) were withdrawn and were replaced by a Collateralised Lending Facility (CLF) in April 1999 under the Interim Liquidity Adjustment Facility (ILAF), wherein commercial banks could borrow funds from the RBI (subject to certain limits) at interest rates equal to or above the Bank Rate. From June 2000, the CLF was withdrawn. Currently, RBI provides financial accommodation to the commercial banks through repos/reverse repos under Liquidity Adjustment Facility (LAF). Additionally, primary dealers are also provided with financial accommodation (borrowing facility) against the collateral of Government securities and treasury bills. Refinance of rupee export credit also continues.

14.2.7.2 Liquidity Adjustment Facility (LAF)

As part of the move from direct to indirect instruments of monetary policy, and to be able to control the money market rates in an effective manner, the Narasimham Committee on Banking Sector Reforms (1998) recommended the withdrawal of all general and sector specific refinance facilities and move towards a liquidity adjustment facility through the operations of repos and reverse repos. Accordingly, an Interim Liquidity Adjustment Facility (ILAF) was introduced with effect from April 21, 1999. According to the ILAF, general refinance facility was withdrawn (refinance of rupee export credit was retained) and was replaced by a collateralised lending facility (CLF). Under CLF, banks could borrow an amount up to 0.25 per cent of their fortnightly average outstanding aggregate deposits for two weeks at the bank rate. An Additional CLF (ACLF) allowed banks to borrow an additional amount of CLF (i.e., additional 0.25 per cent of fortnightly average outstanding aggregate deposit in 1997-98) for two weeks at Bank Rate plus two percent. For an additional period of two weeks beyond the initial two weeks, CLF and ACLF would attract an additional interest rate of 2 per cent above their respective rates (i.e., CLF at Bank Rate plus 2 per cent, and ACLF at Bank Rate plus 4 per cent). Besides, liquidity support to the Primary Dealers were


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provided against the collateral of Government securities at the Bank Rate for a period of 90 days.

The Interim Liquidity Adjustment Facility (ILAF) was replaced by a full-fledged Liquidity Adjustment Facility (LAF) in June 2000. With the introduction of the LAF, the CLF and ACLF stood withdrawn, and the RBI began to manage liquidity in the system through the auction of repos and reverse repos. Initially, RBI conducted auctions of variable rate repos for 1 to 14 days, but later on reverted to auction of fixed-rate repos for 1-day tenor only (3 day tenor on Fridays). However, the RBI deserves the right to re-introduce variable rate repos with longer tenor (of up to 14 days).

Under the earlier system wherein RBI used to control the liquidity in the system through changes in CRR and OMOs, RBI could either influence the quantum of liquidity (by changing CRR) or the cost of liquidity, i.e., the interest rates (through OMO). But after the introduction of the LAF, RBI can control both the quantum of liquidity (by accepting bids up to a certain amount in the repos/reverse repos) and the interest rates. RBI’s control over the interest rates emanates from the fact that the repo rate, that acts as a floor, and the reverse repo rate at 100 basis points above the repo rate, that acts as the ceiling, together provide an informal corridor within which the call money market rates fluctuate.




1) Write three sentences about the role of money market in an economy.

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2) Write five sentences about the RBI’s intervention in the money market.

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3) State whether following statements are True or False.

i) RBI uses repos to absorb liquidity. ( )

ii) RBI uses reverse repos to absorb liquidity. ( )

iii) Treasury bills can only be issued by the Central Government in India. ( )

iv) Treasury bills are issued at a discount to the face value. ( )

v) Commercial banks in India can issue commercial papers. ( )

vi) Non-bank corporates can issue CDs in India. ( )


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14.3 MONETARY POLICY IN INDIA Monetary policy is implemented under what is called a monetary policy framework that consists of: (a) the objectives of monetary policy; (b) the analytics of monetary policy (that focuses on the transmission mechanism); and (c) the operating procedure (consisting of operating targets and instruments). In this section, we will elaborate on these aspects in Indian context.

14.3.1 Objectives of Monetary Policy Price stability (or controlling inflation) and maintaining economic growth are the most commonly pursued objectives by central banks across the world. In view of large-scale financial crises that occurred in a number of countries in the 1990’s (notably in Mexico, South Asia, Brazil and Argentina), achieving financial stability to pre-empt such crisis or to protect the national economy from the ill effects of such crisis occurring in another country has become an additional objective of monetary policy. However, it is often not possible to achieve all these objectives by monetary policy alone. It is because the objectives of monetary policy are interrelated, and there are trade-offs as well. For example, there is often a conflict between inflation and unemployment – inflation can be reduced at the cost of higher unemployment. Similar trade-offs exist among other objectives as well. Thus, in view of multiple objectives, all of which are equally desirable, academicians and policy-makers agree that monetary policy should target price stability, leaving growth and employment to be targeted by fiscal and other policies. Although many developed countries assign the objective of price stability singularly to monetary policy, a notable exception is the US where monetary policy objectives include maximum employment, stable prices and moderate long-term interest rates.

India’s approach in respect of monetary policy objectives takes into account the ground level realities in the country. Accordingly, maintaining price stability and ensuring an adequate flow of credit to the productive sectors (to maintain the economic growth) of the economy have been the major objectives of monetary policy in India. However, depending on the specific circumstances of the year, relative importance attached to the two objectives shift from year to year. In the post-reforms period, a realisation has evolved that in an open economy as India is, in the post-reforms period, maintenance of price stability is more important. This is because in addition to the domestic factors leading to inflation, foreign inflation may automatically get imported into the country if proper safeguards are not adopted. Thus, it is increasingly being recognised that the central bank should target price stability because real growth itself would be in jeopardy if inflation rates go beyond the margin of tolerance.

14.3.2 Analytics of Monetary Policy The process through which monetary policy intervention gets transmitted to the ultimate objectives like inflation or growth is known as “monetary transmission mechanism”. There are four known ways of transmission mechanism, or transmission channels: (a) the quantum channel (e.g., relating to money supply and credit); (b) the interest rate channel; (c) the exchange rate channel; and (d) the asset price channel. The nature and relative importance of these channels in a particular economy depends on the stage of development of the economy and its underlying financial structure. For


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example, the exchange rate channel is expected to be important in an open economy, whereas the quantum channel is likely to be important in an economy where banks are the major source of finance (as against the capital market). Besides, these channels do not function independently of each other, and there could be considerable feedbacks and interactions among them.

14.3.3 Operating Procedures: Instruments and Targets Day-to-day implementation of monetary policy is known as monetary policy operating procedure. Monetary policy seeks to achieve its ultimate objective (of price stability, growth, etc.) through some intermediate targets. These intermediate targets could be exchange rate, money supply growth or a level of interest rate. The RBI has adopted the stance (especially in the 1990’s) that the demand for money function is fairly stable in India, and, hence, a desired level of money supply (broad money or M3) growth has been set as the intermediate target. Accordingly, the RBI sets a desired target of money supply (broad money) growth for the forthcoming period, and announces this target publicly through the Governor’s statement on monetary and credit policy. This targeted rate of growth of money supply is decided keeping in view the expected rate of growth of GDP and a tolerable level of inflation. Given the desired level of growth in broad money, the required expansion in reserve money is then determined given the money multiplier.

However, the fiscal situation and external sector position in particular years are also taken into account while deciding the targeted rate of broad money expansion. For example, if in a particular year, the fiscal deficit increases, and the increased deficit is financed by an increase in market borrowing by the Government, then the reserve money expansion target is modified so as to allow for larger increase in liquidity to accommodate the increased market borrowing of the Government. If this is not done, there will be a shortage of liquidity in the system and the resulting upward pressure in interest rates. Similarly, if the foreign currency inflows suddenly increase in a particular year leading to increase in money supply in the economy, the targeted reserve money expansion must be brought down so that the broad money expansion after the increased foreign exchange inflows do not lead to higher inflation.

14.3.3.1 Instruments of Monetary Policy

Central banks seek to achieve these intermediate targets (for example, broad money expansion) through operation of monetary policy instruments. These instruments are of two types – direct and indirect. The direct instruments include cash reserve ratio (CRR), liquidity reserve ratios, directed credit and administered interest rates. CRR specifies the amount of reserves, banks need to maintain as cash or with the central bank as percentage of their liabilities (deposits). Liquidity reserves ratio, called Statutory Liquidity Ratio (SLR) in India, specifies the amount of money banks must invest in Government securities (and bonds of PSUs) as proportion of their deposits. Directed credit prgramme is used to channelise flow of credit to preferred/priority sectors. Administered interest rates are used to control lending and deposit rates directly. The direct instruments (except administered interest rates) influence the financial system through changing the quantity of credit availability. For example, a fall in CRR or SLR releases certain amount of liquidity into the financial system, which, then, causes the rates to change.

As opposed to this, the indirect instruments generally operate through price channel. That is, these instruments first cause the rates (or prices) to change, which, in turn, causes flow of credit/liquidity to change. The indirect


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instruments consist of the repos (repurchase agreements), Open Market Operations (OMOs), refinance facility, and the discount window of RBI. The repos/reverse repos are used to mop up or inject liquidity for a short duration. OMO is resorted to when the central bank attempts to change the liquidity condition for a longer term. Both these instruments are operated by the RBI at its own discretion. As opposed to this, standing facilities (refinance of eligible export credits) and discount window facility (rediscounting of bills or borrowings from RBI by banks) are accessed by the banks at their discretion.

While the direct instruments are effective (a change in such an instrument almost instantaneously affects the intermediate target), they introduce inefficiency in the market. For example, an increase in CRR (with the objective of reducing liquidity in the system) is applicable to all banks in the system, and, hence, penalises the banks with good liquidity management. Indirect instruments are more appropriate in a market-based system. However, the effectiveness of the indirect instruments depends on the extent of development of the supporting financial markets and institutions. The structure of Indian financial markets has witnessed a gradual transformation in the 1990’s under the regulation of RBI in such a manner that conditions conducive to the operation of indirect instruments of monetary policy have been developed to a satisfactory extent.

14.3.3.2 Operating Targets

The instruments of monetary policy seek to attain a particular level of a variable, known as operating target, in order to achieve the broader objectives like price stability and/or growth. Usually, these operating targets include bank reserves and/or a very short-term interest rate like the over-night inter-bank call money rate. Since late 1980’s, RBI followed the practice of targeting bank reserves in order to achieve the desired level of broad money expansion. However, in view of the evidence that interest channel was becoming important due to structural transformation in the financial sector resulting from reforms, it was felt that targeting bank reserves would be inefficient. Since April 1998, RBI has adopted a multiple indicator-based approach, wherein rates and flows from various markets are monitored and targeted.

14.3.4 Monetary Policy in the Early 1990’s Until the beginning of the 1990’s, before the reforms were initiated, Indian financial market was highly segmented with very little inter-linkages (if any) among the various segments. The money market was in existence, but lacked depth and liquidity. Interest rates – on deposits, credit and Government securities – were highly regulated. Through a high SLR requirement (38.5 in the early 1990’s), the Government used to pre-empt a large portion of the deposits of the banking system at below-market rates. Another significant portion of the lendable resources of the banking sector was directed toward priority sector at highly subsidised rates of interest.

The system of financing of fiscal deficit of the Government through ad-hoc treasury bills (TBs) had serious implications for the conduct of monetary policy. Originally, ad-hoc treasury bill was designed as an instrument to raise short-term credit by the Central Government from the RBI. Over time, it became a practice to roll over the ad-hoc TBs on their maturity, and issuing fresh ad-hocs to raise more finance. Since the ad-hoc TBs were held by the RBI, and not sold to the market, every issue of such TBs amounted to increase in money supply in the economy. Had RBI was in a position to re-sell these TBs to the market, it would have meant a transfer of purchasing power from


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the market to the Government through a loan, and not addition to the purchasing power in the system. Even in the situation prevalent at that time where RBI could not re-sell the ad-hoc TBs to the market, had the ad-hocs been repaid on their maturity, the money supply would have reduced by an equal amount. But continuous roll-over and fresh issuance of ad-hoc TBs amounted to continuous increase in money supply. Thus, the fiscal deficit of the Central Government used to be continuously financed automatically through creation of money. This process is known as automatic monetisation of Government deficit. Apart from the ad-hoc TBs, the RBI had to purchase dated Government securities that were not taken up by the market. These two components (RBI’s purchase of ad-hocs and dated Government securities) together constitute Net RBI Credit to the Central Government, and increase in this figure during a period represents increase in reserve money during that period.

Automatic monetisation of deficits led to considerable upward pressure on the prices. Consequently, the rate of inflation continued to be rather high on a sustained basis since the 1960’s through the 1990’s (excepting first half of 1980’s), although intermittent supply shocks like the oil price hike of 1973 and late 1970’s played a role in some of the years. To curb the adverse impact of automatic monetary expansion on the prices, CRR was raised gradually from 3 per cent in the early 1970’s to 15 per cent in the early 1990’s.

Apart from automatic monetisation of Government deficits, rising deficits of the Central Government throughout the 1960’s, 1970’s and 1980’s were also financed by the banking system through its support of the former’s borrowing programmes. Initially, interest rates on Government securities were kept artificially low to minimise the cost of Government debt, but had to be increased later on to improve their attractiveness. Even the higher interest rates were not enough to get voluntary subscription. Consequently, in order to force the banks to subscribe to the Government securities, the SLR was gradually raised to 38.5 per cent by early 1990’s.

In this situation of continuous increase in money supply, monetary policy had very little room to play. Monetary policy concentrated on neutralising the inflationary impact of fiscal deficits with the use of direct instruments, especially CRR. Thus, monetary policy used to play no more than a second fiddle to the fiscal policy.

By early 1990’s, both CRR and SLR reached very high and close to their maximum permissible levels, and, hence, lost their effectiveness as monetary policy instruments in an economic environment characterised by continuous monetary expansion. Thus, the situation became unsustainable by the early 1990’s, and reforms became unavoidable.

14.3.5 Monetary Policy in the Late-1990’s Onwards Conduct of monetary policy has undergone a sea change following reforms in the financial sector. Apart from changes in objectives and targets including operating targets of monetary policy, there has been a gradual shift from direct instruments to indirect instruments. The shift has been made possible by the significant reforms in the structure of financial markets.

Until 1997-98, monetary policy used to be conducted in India with expansion of broad money (M3) as an intermediate target. The desired rate of growth of M3 used to be determined keeping in view the expected GDP growth and a projected level of inflation. Reforms in the financial sector have brought about changes in the transmission mechanism of monetary policy with interest rate


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channel gaining importance. The earlier approach was then replaced with a multiple indicator-based approach since 1998-99. This means that targeted growth in M3 or bank reserves were not determined simply in view of expected GDP growth and expected inflation, but in the light of recent trends in a range of other variables as well – rates of return in different markets (money, security and Government securities), credit growth, exchange rate, capital flows, etc. In other words, although bank reserves remain the operating target, other rates and flows are also targeted to fine tune the financial system.

The shift from the direct instruments to indirect instruments has been made possible through a series of carefully crafted and correctly sequenced steps of reforms as explained below.

a) OMOs (including repos) were re-activated in 1992-93 in order to develop a market-based mechanism to inject/absorb liquidity from the system.

b) The Liquidity Adjustment Facility (LAF) was introduced in two phases in April 1999 and June 2000. The Reserve Bank is now able to control liquidity in the system on a daily basis through repos/reverse repos under LAF. This was impossible in the earlier structure when CRR was the primary tool to control liquidity, because CRR could be changed at best on a fortnightly basis. The RBI absorbs liquidity at the fixed repo rate (currently 5 per cent) at times of excess liquidity, and injects liquidity at times of tight monetary conditions through reverse repo rate fixed at 100 basis points above the repo rate. Thus, these two rates provide an informal corridor within which call money rates and other short-term rates fluctuate. This is because if call money rate goes below the repo rate, banks can borrow funds from the call money market and park the same with RBI at the fixed repo rate and can make some sure profit. Similarly, if the call money rate goes above the reverse repo rate, banks can borrow from the RBI at the reverse repo rate and lend in the call money market, and can make some sure profit.

c) The Bank Rate was re-activated in April 1997. Initially, all financial accommodation extended by the RBI was linked to this rate. With gradual development of the repo/reverse repo market and introduction of LAF, Bank Rate is used more to signal the RBI’s view of interest rates to the market.

d) In order to disentangle monetary policy from the clutch of fiscal policy, an auction system for the Central Government’s market borrowing programme was introduced in June 1992. After this, an increasing portion of fiscal deficit was financed by market borrowings at market-determined rates of interest. The system of ad-hoc treasury bills was terminated in 1996-97, and automatic monetisation of fiscal deficit through ad-hoc treasury bills was discontinued from April 1997.

e) The interest rates were deregulated gradually with lending rates deregulated first followed by deregulation of deposit rates. Starting from September 1991, a system of prescription of multiple rates for loans to various sectors and various sizes were gradually withdrawn (except for a few areas like agriculture, small scale industries and export credit). The minimum lending rate was withdrawn and banks were given full freedom to determine their lending rates for loans above Rs. 2 lakh in October 1994. At the same time, banks were required to announce prime lending rate (PLR). Later on, banks were allowed to set different PLR for different maturities, and also to lend at sub-PLR (below PLR) rates to highly creditworthy borrowers.


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f) Deposit rate deregulation started in April 1992 with removal of RBI-prescribed multiple rates for different maturities and replacing these with a single ceiling rate. Afterwards, the scope of the ceiling rate was gradually reduced by removing the ceiling on deposits of maturity of over two years in October 1995, on deposits of over 1 year maturity in July 1996, and on all deposits in October 1997. The only deposits rate that is currently determined by RBI is the savings bank rate (currently at 3.5 per cent since March 2003).

g) Interest rate deregulation is not enough for the market-based indirect instruments of monetary policy to be effective. This was required to be supported by the development of the missing segment of the financial market – a vibrant market for short-term funds.

The size and efficiency of the short-term segment of the financial market (i.e., the money market) is crucial for the conduct of monetary policy. Larger is the depth and breadth of this market, easier it is for the monetary policy instruments to achieve its goal of influencing the operating target. The more efficient the money market is, the less time a change in the monetary policy instrument takes to affect the operating target, i.e., the higher is the speed of adjustment.

Two factors explain the underdevelopment of the shorter end of the financial markets until the early 1990’s – cash credit facility offered by the commercial banks to its borrowers, and the availability of the 4.6 per cent on tap treasury bills.

Under the cash credit system, borrowers were given a limit up to which they could borrow at their discretion. Thus, when they required credit, they drew from the limit and when they were in surplus, they paid back the excess cash to the bank. This system meant that the corporates did not have to enforce a discipline of cash management on them. Instead, the onus of cash management was on the banks. As a result, there was a lack of interest from the non-bank players, especially the corporates, in a market for short-term funds. The availability of the on tap treasury bills (at a fixed yield of 4.6 per cent) was the other factor responsible for the absence of a market for short-term funds. With the gradual introduction of a loan system in place of the cash credit system from April 1995, the onus of cash management was shifted back on the corporates. This, along with the discontinuation of the on tap treasury bills from April 1997, has led to a substantial improvement in the breadth and depth of the market for short-term funds.




1) Unlike many other central banks, why is it difficult for the RBI to adopt price stability as the single objective of monetary policy?

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2) What is the distinction between direct and indirect instruments of monetary policy?

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3) Explain how the ad-hoc treasury bills were used as a mechanism to automatically monetise the fiscal deficit.

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i) LAF is used to control liquidity shocks of a temporary nature, while OMOs are used to control liquidity shocks of a relatively more enduring nature. ( )

ii) CRR and SLR are indirect instruments of monetary policy. ( )

iii) OMOs and repos are direct instruments of monetary policy. ( )

iv) Automatic monetisation of Central Government deficits through ad-hoc treasury bills had been discontinued since 1997-98. ( )

v) All interest rates except the one on savings bank deposits are now market determined. ( )

14.4 LET US SUM UP Over the period, as the financial markets developed, inter-linkages between the various segments of the financial markets (short-term debt market, long-term debt market, foreign exchange market) grew. This created increasingly more conducive conditions for the use of indirect instruments. Consequently, the reliance on direct instruments has been gradually reduced, and indirect instruments have increasingly been resorted to by the RBI to fine-tune the financial markets. In the emerging scenario, OMO (in the form of outright sale/purchase of dated Government securities) has become the primary tool to absorb liquidity shock of a relatively enduring nature. Liquidity Adjustment Facility (LAF) operated through daily repo/reverse repo transactions has been the major tool to regularise short-term liquidity shocks.

14.5 EXERCISES 1) Examine the role and significance of a well-developed money market in

the process of economic growth of a country.

2) Discuss the different constituents of money market in India. Also examine the mechanism of RBI intervention in the money market.


44

3) Briefly explain the objectives of monetary policy in an economy. Also discuss the instruments and targets of monetary policy as practised by the Reserve Bank of India.

4) Make a critical evaluation of the monetary policy of the Reserve Bank of India.

14.6 KEY WORDS Bank Rate: Bank Rate is the rate of interest, announced by the Central Bank, at which it rediscounts securities of commercial banks like discounted bills of exchange, treasury bills.

CRR (Cash Reserve Ratio): Commercial banks are required to maintain a portion of their total deposits (demand deposits, i.e., savings bank deposits and current account deposits, and time or fixed deposits) in cash and/or as deposit with central banks. This is known as Cash Reserve Ratio (CRR). According to the Banking Regulation Act, 1949, RBI can vary the CRR between 3 per cent and 15 per cent. This is a direct instrument of monetary policy used by the RBI until the late-1990’s. An increase (decrease) in the CRR reduces the funds available to the banks for lending, and tightens (loosens) the liquidity conditions in the economy.

Money Supply: Aggregate money supply is argued to be the major determinant of inflation in an economy with a stable demand for money function. The most commonly used definitions of money supply are M1 (or narrow money), M2 and M3 (or broad money). Narrow money, as the name suggests, is a narrow definition in the sense that it includes two most liquid monetary assets – currency with the public (currency notes and coins in circulation plus cash in hand with banks) and deposit money of the public (demand deposits with banks plus other deposits with RBI). Since demand deposits (or checkable deposits – basically savings bank deposits and current account deposits) can be converted into cash at any point of time, this is almost as liquid as currency with the public. M2 includes M1 and post office savings bank deposits. M3 (or broad money) is defined as M2 plus time deposits with banks.

Reserve Money: Reserve money is the reserves maintained by commercial banks against their deposits and the currency in circulation (with non-bank public). All deposit-taking commercial banks are required to maintain a percentage of their deposits with the Central Bank. This percentage is known as statutory reserve ratio (or Cash Reserve Ratio or CRR in India).

Reserve Money = Required Reserve + Excess Reserve + Currency in Circulation.

Central banks can directly control the reserve money through various instruments at its disposal. Changes in reserve money lead to changes in money supply (M3) through the operation of the money multiplier.

Scheduled Commercial Bank: A commercial bank whose name appears in the Second Schedule of the Reserve Bank of India Act, 1934, is known as Scheduled Commercial Bank.

SLR (Statutory Liquidity Ratio): Commercial banks are required to maintain a certain percentage of their total demand and time liabilities in liquid assets like approved securities (mostly securities of the Central Government and State governments and bonds issued by the PSUs), gold and cash (apart from CRR). According to the RBI Act, the RBI can vary this ratio


Monetary Policy

45

between 25 per cent and 40 per cent. Currently, this ratio is fixed at 25 per cent. In the past, especially up to the early 1990’s, RBI has used the SLR requirement extensively as a monetary policy tool.

All India Financial Institutions (AIFIs): All-India Financial Institutions (AIFIs) comprise five All-India Development Banks (AIDBs), viz., Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India Ltd. (IFCI), ICICI Bank Ltd., Infrastructure Development Finance Corporation (IDFC), Small Industries Development Bank of India (SIDBI) and Industrial Investment Bank of India (IIBI, erstwhile Industrial Reconstruction Bank of India or IRBI), three Specialised Financial Institutions (SFIs) viz., IVCF (erstwhile Risk Capital and Technology Corporation or RCTC), ICICI Venture (erstwhile TDICI) and Tourism Finance Corporation of India (TFCI) and three investment institutions viz., Life Insurance Corporation of India (LIC), Unit Trust of India (UTI) and General Insurance Corporation (GIC).


Bhole, L.M. (2004); Financial Institutions and Markets: Structure, Growth and Innovations, Fourth Edition, TATA McGraw Hill, New Delhi.

Machiraju, H.R. (2004); Indian Financial System, Vikas Publishing House, New Delhi.

Reddy, Y.V. (2002); Parameters of Monetary Policy in India, Lecture delivered by Dr. Y.V. Reddy, Deputy Governor, Reserve Bank of India, at the 88th Annual Conference of The Indian Econometric Society at Madras School of Economics, Chennai on January 15, 2002.

Reddy, Y.V. (2005); Monetary Policy: An Outline, Presidential Address by Dr. Y.V. Reddy, Governor, Reserve Bank of India circulated in the Annual Conference of Andhra Pradesh Economic Association, on February 12, 2005 at Vishakhapatnam.

Reserve Bank of India, Report on Currency and Finance, 2001-02, 2003-04.



1) Go through Section 14.2 carefully and get your answer.

2) See Sub-section 14.2.7

3) i) True

ii) False

iii) True

iv) True

v) False

vi) False


1) If inflation would have caused primarily by monetary factors, monetary policy could pursue the single objective of price stability. But that is not the case in India. In India, inflation is caused by monetary factors


46

(increase in money supply at a rate much beyond what is required to support the output growth) as well as by non-monetary factors including structural factors (sectoral demand supply imbalance) and supply shocks (e.g., oil price hike, rise in international prices). Besides, in view of high level of fiscal deficit and consequent market borrowing by the Central and State governments, monetary policy has a role to accommodate Government borrowing at a low cost. This implies that the debt management function gets inextricably linked with the monetary management function while steering liquidity conditions. Finally, the absence of fully integrated financial markets means that the interest rate transmission channel of policy is rather weak and yet to evolve fully. The substantial lag in a change in monetary policy and its effect on bank lending rates constrain the adoption of inflation targeting.

2) Go through Sub-section 14.3.3 carefully and get your answer.

3) Go through Sub-section 14.3.4 carefully and get your answer.

4) i) True

ii) False

iii) False

iv) True

v) True

47

UNIT 15 CAPITAL MARKET IN INDIA AND WORKING OF SEBI

Structure

15.0 Objectives 15.1 Introduction 15.2 Developments since Independence 15.3 Indian Equities Market as of 1992 15.4 Reforms in the Indian Capital Market

15.4.1 Institutional Reforms 15.4.2 Impact of Reforms

15.5 Let Us Sum Up 15.6 Exercises 15.7 Key Words 15.8 Some Useful Books 15.9 Answers or Hints to Check Your Progress Exercises

15.0 OBJECTIVES The primary objective of this unit is to develop an idea of the securities market infrastructure and how such market functions in the country. After going through this unit, you will be able to:

• state the nature of the problems that beset the country’s stock market for almost a century until the early 1990’s;

• explain the radical reforms that led of world class securities market infrastructure within a short span of less than a decade; and

• analyse the underlying processes of the functioning of stock markets.

15.1 INTRODUCTION While the money market is a market for short-term debt (up to one year maturity at the time of issue), the capital market is a market for long-term debt as well as equity shares. In this market, debt and equity instruments are issued to the public as well as placed privately to a select group of investors. The stock exchanges are also part of this market, where most of these instruments are traded. Thus, the capital market consists of broadly two segments: primary market and secondary market. Primary market refers to the market for new issues of these securities. Once the securities are issued, they are traded in what is called the secondary market. Both equities and debt are traded in the secondary market.

There are basically three categories of participants in the capital market – the issuer of securities, the investors in securities and the intermediaries. The issuers are the borrowers or deficit savers, who issue securities to raise funds. The investors, who are surplus savers, deploy their savings by subscribing to these securities. The intermediaries are the agents who match the needs of users and suppliers of funds for a commission. There are a large variety of intermediaries providing various services in the Indian securities market.

The corporate sector as well as the Central Government and State Governments issue securities in the primary market. While the primary market helps the corporate sector to raise fresh capital for financing investment in


48

productive assets, the Government sector issues securities in the primary market mainly to finance a part of their deficits. The investors in the capital market include the retail investors (i.e., Indian public), mutual funds, Foreign Institutional Investors (FIIs), Financial Institutions (like LIC, GIC, IDBI, IFCI, etc.), banks, etc.

For the investor, the secondary market provides the much needed liquidity and information on asset prices. Investors supply capital to the users of capital (corporate and Government sector) in the primary market. In the absence of a secondary market, many of the investors would probably not agree to supply capital in the primary market because they would not have an exit route for their investment. The secondary market provides this exit route. Secondly, through active trading by millions of investors, prices of securities are established in the secondary market. This price information is used to judge the corporate performance (share prices) or performance of the Government and the economy (through interest rates on Government debt). Price information provided by the secondary market also guides managerial decision-making. Secondary market also provides the platform for monitoring and control – by facilitating value-enhancing control activities (mergers & acquisitions) and enabling implementation of incentive-based management contracts (employee stock options).

The Securities and Exchange Board of India (SEBI) is the regulatory authority that regulates both the primary and secondary markets. The basic role of SEBI is to protect the interests of the investors in securities and to promote the development of the securities market.

Stock market in India has a history of over 200 years, although the first organised stock exchange was established in 1875 in Bombay (now Mumbai).

15.2 DEVELOPMENTS SINCE INDEPENDENCE The developments in the Indian capital markets since Independence can broadly be divided into four distinct phases. The first phase (1947-1973) was characterised by institution-building, the second phase (1973-1980) was characterised by deep-seated changes triggered by the enactment of the Foreign Exchange Regulation Act (FERA), the third phase (1980-1992) witnessed an unprecedented broadening and deepening of the markets and emergence of a set of new generation institutions and market segments. The final phase (1992-till date) is characterised by widespread reforms and a dramatic transformation of the capital markets, along with the introduction of foreign institutional investors (FIIs), emergence of the National Stock Exchange (NSE) as the pre-dominant stock exchange and the Securities and Exchange Board of India (SEBI) as the major regulator. In this unit, the focus is on the fourth phase. However, first three phases are also described briefly.

After Independence, the country lacked the base of heavy and basic industries that form the backbone of industrial development. Development of such industries, which are usually characterised by long gestation period, required supply of long-term capital. But the banking system provided predominantly short-term finances (as their deposits were at best of medium-term); the corporate debt market did not exist at that time. Consequently, the country lacked a dependable source of long-term capital. To fill this lacuna, a number of Development Financial Institutions (DFIs) were set up – IFCI (in 1948), ICICI (1955), IDBI and UTI (1964). The State governments also set up state-level organisations for promotion and financing of industries during the 1950s and 1960s. Thus, the first phase of capital market development since

Capital Market in Indiaand Working of SEBI

49

Independence that lasted up to 1973 was characterised by institution-building. The focus was on building institutions to provide institutional finance. Barring the establishment of UTI, not a single entity was created by the Government to foster capital market development during this phase.

However, this period witnessed the development of a solid legal framework for the capital markets. Legislations like Capital Issues (Control) Act, 1947, Securities Contracts (Regulation) Act, 1956 and Companies Act, 1956, which were to shape the capital market development in the following years, were enacted.

In short, the first phase up to 1973 witnessed the development of institutions and a legal framework for orderly development of the capital market consistent with the planned industrial development of the country. The dependence of the industrial sector on shares and debentures (or public capital markets) as source of finance during the 1950s and 1960s was insignificant. One major reason was the availability of cheap (subsidised) credit from the DFIs (long-term) and banks (short-term). Another reason was the lack of popular participation to any significant extent.

The enactment of FERA in 1973, that required foreign ownership in Indian joint venture companies to be brought down to 40 per cent to be regarded as an Indian company, ushered in a new phase of capital market development. The well-managed multinational companies had to offer shares to the Indian public at a very low price in the 1970s because issue price used to be regulated by stringent formulae laid down by the CCI. This evoked tremendous response from the public. Drawing a clue from the MNCs, a number of domestic companies also made successful public issues to raise equity capital. The secondary market also witnessed sustained rally. All these led to a large number of individuals being brought into the capital market for the first time.

The third phase of capital market development (1980-1992) began with the limited liberalisation of the industrial sector in the early 1980s. Riding on buoyant industrial performance resulting from liberalisation, the share prices boomed. This was followed by another boom in the primary market, and another round of widening of the equity culture among the masses. As can be seen from Table 15.1, while only two exchanges were set up during 1946-1980, as many as five stock exchanges were established during the following five years (1980-85), and another six during the next five years (1986-1991). Apart from number of stock exchanges, other parameters of stock market development – the number of companies listed, number of issues of listed companies and market value of capital – registered a significant growth during the 1980s. Another point to be noted was that debentures became an important source of capital for the corporate sector in the late 1980s.

Apart from strong growth in stock markets, the later half of the 1980s witnessed establishment of a few new institutions. The culture of credit rating was introduced for the first time in the country through establishment of three credit rating agencies (CRISIL, ICRA and CARE) during this phase. The SEBI was also established (1988) during this phase, although the regulator had to wait for four more years to obtain statutory power. The securities scam marked the end of this phase and beginning of a new phase. The scam exposed the weaknesses and loopholes of Indian capital market and called for widespread reforms. Incidentally, the need for reforming the capital market was also felt as part of the overall economic reforms programme initiated in 1991.


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Table 15.1: Growth of Indian Stock Market

As on 31st December 1946 1961 1971 1975 1980 1985 1991 1995 1 No. of Stock Exchanges 7 7 8 8 9 14 20 22 2 No. of Listed Cos. 1125 1203 1599 1552 2265 4344 6229 8593 3 No. of Stock Issues of Listed Cos. 1506 2111 2838 3230 3697 6174 8967 11784 4 Capital of Listed Cos. (Cr. Rs.) 270 753 1812 2614 3973 9723 32041 59583 5 Market Value of Capital of Listed

Cos. (Cr. Rs.) 971 1292 2675 3273 6750 25302 110279 478121

6 Capital Per Listed Cos. (Lakh Rs.) (4/2)

24 63 113 168 175 224 514 693

7 Market Value of Capital Per Listed Cos. (Lakh Rs.) (5/2)

86 107 167 211 298 582 1770 5564

8 Appreciated Value of Capital Per Listed Cos. (Lakh Rs.)

358 170 148 126 170 260 344 803

Source: Bombay Stock Exchange Official Directory, Various issues.

The fourth phase (1992 onwards) witnessed a dramatic structural transformation of the capital markets. All aspects of the Indian capital market – operations, regulations, intermediation costs, fund mobilisation, technology, geographical spread, globalisation, public access – changed beyond recognition. The end result is the creation of a securities market infrastructure within the span of less than a decade that can be compared with only the very best among the developed markets.

15.3 INDIAN EQUITIES MARKET AS OF 1992 The problems of the secondary equity market, at the time, may be summarised as follows:

• Although there were almost 20 regional stock exchanges, trading was concentrated in Bombay Stock Exchange and it enjoyed a monopoly within the city of Bombay. Users from outside Bombay found it extremely difficult to trade in BSE due to poor technology and high cost of telecommunications. BSE imposed a high entry barrier, so that competition among brokers was absent. The intermediation services provided by the brokers were, thus, extremely inefficient and costly.

• The exchange limited the membership to individuals; doors were closed to the limited liability firms. This led to an extremely inefficient form of business organisation and low level of technology. Securities markets are inherently complex and these factors rendered the quality of service delivery poor.

• Trading was characterised by “open outcry” system, wherein trading used to take place in trading ring where non-brokers were not allowed in. Neither was there any mechanism to verify the prices at which trading actually took place. Consequently, brokers used to charge prices to the investors (buyers and sellers of securities) that were usually different from the actual prices and to the disadvantage to the latter (e.g., brokers used to report higher than actual prices for buy orders and lower than actual prices for sell orders). If investors (buyers or sellers) demanded a more accurate price, orders often got cancelled (for example, the broker could simply claim that such a favourable price was not obtained in the market).


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• BSE being an association of brokers who ran the affairs of the exchange, enforcements of rules and regulations (which meant penalising themselves against unlawful activities) were conspicuous by their absence. Brokers habitually resorted to manipulative practices, and went scot-free on every occasion.

• The settlement system (payment of money and delivery of securities after trade) followed by BSE was primitive, fraught with high degree of risks, favoured the brokers and was to the disadvantage of the investors. First, the settlement was “futures-style” and was on a fortnightly basis. This means that trading done during a fortnight would be settled at the end of the fortnight. On that date, only the net position would be settled, rather than each buy and each sell. Besides, the system of badla enabled the brokers to carry forward their liability (of money or securities) to next settlement. Consequently, brokers could postpone settlement almost indefinitely. This led to a high degree of risks. For example, brokers could take on position (long ⎯ by buying without paying the money, or short ⎯ selling while not owning the stock), and could postpone settlement if prices tuned unfavourable to them. This process had to end sooner or later, when failure to settle (pay the money or deliver the securities) would lead to a systemic crisis.

• BSE provided in-house clearing facility to only top 100 scrips, and clearing and settlement for all other scrips were done bilaterally. Even for the top 100 scrips, the clearing function lacked mandatory element in the sense that if cash and stocks arose from two sides (buyers and sellers), the exchange matched them. All these had the consequence of increasing the counter-party risk (i.e., the risk that one of the two parties in a transaction may fail to honour their commitment to pay cash [buyer] or stock [seller] on the scheduled settlement date). Almost every settlement witnessed problems of partial or delayed payment. Large-scale problems arising out of failure to make payment or deliver shares, leading to closure of BSE for days together, used to recur at the rate of almost once every other year.

• Last but not the least was the problem of “bad delivery”. After buying the shares, and after getting them delivered in his hands, the investor had to send the shares to the registrar of the company to register the ownership in his name. At this stage, the problem of bad delivery arose due to a number of problems most of which were not the creation of the investor. The primary among these reasons used to be inaccurate signature verification of the seller of the shares. That is, if the signature of the seller did not match with the one maintained with the registrar, the shares were sent back. The seller of the shares, who probably purchased the shares years back, might unwillingly sign in a different manner. But in many cases, manipulations by unscrupulous operators were responsible. Examples of such manipulations included counterfeit shares (wherein any signature were put by the counterfeiter), and engineering bad deliveries by selling party’s brokers or by the companies themselves to delay settlement in order to support price manipulation. The time lag between buying shares and getting it registered in the name of the buyer used to take anything between one to three months if everything was alright. The time lag normally went up to six months on an average in case of bad delivery.

The primary market in the early 1990s had its own set of problems. The major problem of the primary market was extremely restrictive regulations on the issuers enforced by the Controller of Capital Issues (CCI). First of all,


52

stringent criteria of entry allowed very few companies to raise capital by making public issues. Even those companies who could get an approval from the CCI were not free to price their issues. Formula suggested by the CCI had to be adopted in pricing the capital issues, which often resulted in severe underpricing of issues. Almost every maiden public offer of equity shares (known as Initial Public Offering or IPO) used to attract subscriptions for shares many times the number of shares offered. This resulted into a system of lottery wherein a relatively few lucky investors got allotment and the majority of the applicants did not get any allotment. Such shares used to get listed at prices far above the issue price resulting into wealth losses by the issuing companies because such companies could have issued the shares at a much higher price (if the CCI allowed).

The country started with overall economic reforms in the real sectors in 1991. The financial sector could not be far behind. The securities market scam of 1992 acted as a trigger. Wide-ranging reforms were initiated in the Indian capital markets in late-1993.

Check Your Progress 1 Note: i) Space is given below each question for your answer. ii) Check your answer(s) with those given at the end of the unit.

1) List the distinct shares of development of capital market in India. What were the peculiar phases of IIIrd phase?

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2) Point out two major problems of the Indian securities markets in the early 1990s.

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i) SEBI was established in 1988. ( )

ii) SEBI was the capital market regulator before May 1992. ( )

iii) NSE displaced BSE as the largest stock exchange in India within one year of its establishment. ( )

iv) The equity market has achieved a state of substantial importance in the National Economy since 1980s. ( )

v) The Controller of Capital Issues (CCI) regulated the pricing and issue of new securities until May 1992. ( )


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15.4 REFORMS IN THE INDIAN CAPITAL MARKET

The radical changes and the consequent improvement in securities market infrastructure that the Indian capital markets witnessed during the 1990s have been made possible by a remarkable success in the institution-building process.

15.4.1 Institutional Reforms Creation of four new securities market institutions characterised the process of institution-building from the late 1993 onwards – the Securities and Exchanges Board of India (SEBI) (although it was set up in 1988, it was given statutory status in 1992, and started to function effectively in 1993). The National Stock Exchange (NSE) with its wide network across the country has become the premier stock exchange in the country. The National Securities Clearing Corporation (NSCC) and the National Securities Depository Limited (NSDL) are other securities market institutions.

The SEBI

The Securities and Exchanges Board of India (SEBI) was formed in 1988. However, SEBI attained statutory status in May, 1992 only after the repeal of the Capital Issues (Control) Act, 1947 and the consequent abolishment of the regulatory organ under this Act, viz., the Controller of Capital Issues. Since then, SEBI has gradually adopted many important roles in the area of policy formulation, regulation, enforcement and market development. Although the stock exchanges were legally under the control of the Ministry of Finance, they practically functioned like brokers’ clubs in an independent and unaccountable manner. They were brought under regulation for the first time under the regulatory purview of SEBI.

Today, SEBI supervises almost every element of the capital markets – including regulation of intermediaries, curbing malpractices like market manipulation and insider trading, development of fair practices by the intermediaries, development of the market, awareness creation among investors, and so on.

The National Stock Exchange (NSE)

NSE was a new exchange promoted and owned by public sector financial institutions (like IDBI, UTI, LIC, GIC, IFCI, etc.) and banks. Establishment of NSE as a professionally-managed (as opposed to the other exchanges that are managed by brokers or members still today) marked a radical break with the past. Four key innovations were brought about with the establishment of the NSE:

First, physical, floor-based, brokers-dominated trading outside the eyes of the investors was replaced by anonymous, computerised order matching system where trading is done in front of the investors. The order-matching system is characterised by strict price-time priority, wherein an order is executed according to the price parameters set by the investors.

Second, use of satellite communication system to spread the reach of the exchange to all over the country was attempted successfully, for the first time, by NSE. This was in stark contrast to the other exchanges which till then had the reach limited to their cities of operation for over a century.


54

Third, the traditional exchanges were and still are managed by the member brokers. This gave rise to many malpractices, a conflict of interest being the most important one. Since the brokers themselves were in charge of enforcement of rules and regulations, they never took a decision in favour of the investors that went against their interest. This gave rise to a conflict of interest between the members as brokers and members as responsible for enforcement of rules and regulations. NSE avoided this problem right from beginning because it was set up as a limited liability company with brokers as franchisees. This led to a situation where brokers were not held responsible for enforcement of rules and regulations, and those who were entrusted with enforcement (professional managers) were not brokers. As a result, NSE’s staff is free of pressures from brokers and is better able to perform regulatory and enforcement functions.

Fourth, the traditional practice of fortnightly settlement cycle along with the system of badla that allowed extension of even this fortnightly cycle was replaced by a strict weekly settlement cycle without badla.

Equity trading at NSE commenced in November 1994. Within one year of operation, NSE surpassed the BSE in terms of turnover. It is, thus, not surprising that BSE rapidly responded to NSE by adopting similar trading technology (but with the same ownership structure and consequent conflict of interest) in March 1995. In other words, NSE suddenly introduced a huge dose of competition in a market habituated to monopoly practices for over a century. This almost immediately led to drastic improvement in at least five aspects:

i) Improved Transparency: Investors can see with their own eyes the prices that are currently being quoted in the market, and choose to trade or not.

ii) The electronic trading platform makes trading completely anonymous. Traditionally, lack of anonymity in trading in the floor-based system gave rise to cartels (of brokers) and made price manipulation easy. NSE was a break from this tradition as well and removed much of the scope for price manipulation.

iii) NSE throws open the business of stock broking to all and everyone (subject to fulfillment of certain criteria). In contrast, BSE restricted new entry into the brokerage business until NSE came into picture. More than a thousand brokers entered the market with the NSE leading to steep increase in competition and the consequent fall in the brokerages by a very substantial amount. This led to a drastic fall in transaction costs.

iv) Automation of the trading system eliminated all the problems associated with manual trading (e.g., bad delivery) and allowed NSE to set a high standard of operational efficiency.

v) Investors from all over the country have got access to an exchange on same terms and conditions as investors within Mumbai for the first time. Earlier, Bombay stock exchange was the pre-dominant one in the country, but investors outside the city found it extremely difficult and costly to do business in the exchange. Thus, true to its name, NSE turned out to be the first national stock exchange. This benefited the investors from outside Mumbai more than perhaps the investors within the city.


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National Securities Clearing Corporation Limited (NSCCL)

The NSE promoted National Securities Clearing Corporation Limited (NSCCL), the first clearing corporaion of the country, in August, 1995 as its wholly-owned subsidiary. NSCCL started clearing operation from April 1996. NSCCL introduced the practice of settlement guarantee and settlement guarantee fund for the first time in India. The concept of “innovation” introduced by NSCCL revolutionised clearing and settlement in the country by reducing counter-party risk to almost zero. This is how it works. For every trade (buy or sell) done on the NSE, NSCCL becomes the counter-party. That is, the seller sells the securities to the NSCCL, and the buyer buys from the NSCCL. In reality, NSCCL becomes the legal counter-party to the net obligations of each brokerage firm. Even if a brokerage firm fails to make payment (or deliver securities), NSCCL makes the payment (or deliver securities). This has almost eliminated counter-party risk and contained the recurrence of payment crises that characterised Indian stock markets for almost a century.

However, the counter-party risk is now borne entirely by NSCCL. To protect itself from the counter-party risk, NSCCL has adopted a two-pronged strategy. First, it has reduced the possibility of default itself through a variety of means. For example, certain minimum net worth requirement (including a portion of it maintained as deposit with NSE) has been specified by the brokers; a sophisticated risk management system has been instituted by the NSE & NSCCL so that the risk never exceeds a certain pre-specified level (through application of the concept of Value at Risk). An innovative method of on-line monitoring of positions of brokers and investors has been devised. All these have substantially reduced the probability of default and reduced the potential loss to NSCCL. Second, whatever risk still remains is covered by a settlement guarantee fund (SGF) whose corpus has slowly been built over the years and stands at Rs. 1,550.90 crore as on 31st March, 2004.

NSCCL has an uninterrupted track record of implementing every settlement on time since inception. It marks an important milestone in the institutional development of India’s financial system.

Competitive pressure from NSE-NSCCL and directives from SEBI forced other stock exchanges to set up their own clearing corporations and SGF. The Bombay Stock Exchange set up SGF in 1997 and other exchanges followed suit later on. By 1999, all the major stock exchanges (11 stock exchanges apart from NSE) set up their own clearing corporations and SGF.

National Securities Depositories Limited (NSDL)

The trading and settlement using electronic trading was made possible because of dematerialisation of share holdings of investors. The dematerialised shares are held in depositories. In November 1996, the National Securities Depository Ltd. (NSDL), the first depository in India, was established. With the shares dematerialised with the depository, the potential for theft and counterfeiting of shares, bad delivery and the likes was eliminated. SEBI played an active role in gradual shifting from physical certificates to dematerialised holding by introducing a mandatory element in the process. Currently almost cent percent trading and settlement are done in a dematerialised environment.

15.4.2 Impact of Reforms Indian securities markets were radically transformed owing to deep-routed institutional reforms and innovations carried during a short period of four


56

years (1994-1998). All these changes have vastly improved market practices, sharply lowered transactions costs, and improved market efficiency. In no other part of India’s financial sector has such a radical reforms agenda been executed, in such a short time.

The most visible change of all has been the shift from physical, floor-based non-transparent trading system to a transparent and efficient electronic trading system. The OTCEI, which was set up in 1992, was the first computerised exchange in India. This has been made possible by creation of the supporting infrastructure (depositories) and introduction of innovative practices (dematerialisation, novation). The NSE started operations in 1994 with electronic trading, while all other exchanges introduced electronic trading subsequently. Till 1996-97, 16 exchanges in the country had shifted to electronic trading and in the year 1997-98 four more exchanges established these facilities. By March 31, 1999, all the 23 stock exchanges in the country had computerised on-line screen based trading.

Second, the counter-party risk and possibility of recurrent payment crisis have almost been eliminated.

Third, the earlier system was characterised by segmented markets fragmented through geographical distance where it was a telephonic market (for rest of the country other than Mumbai). The new system achieved a national market with equal access to everybody, and, hence, was successful in achieving aggregation and revelation of order flow (i.e., market demand and supply) on a nation-wide basis.

Fourth, the brokers (the most important intermediary) were fraught with agency problems, practised oligopolistic pricing and cartelisation. The new system dispensed with all these ills. Competitive pricing practices emerged, that led to a substantial fall in transaction costs (by a factor of one-tenth for investors outside Mumbai).

Fifth, the new system ensured timely settlement, unlike the previous system where settlement lacked the mandatory element and was irregular.

Sixth, the enforcement of rules and regulations has been strict in the new system and is in stark contrast with the earlier system.

Seventh, once a world-class securities market infrastructure was set up, introduction of derivatives (futures on individual stocks and on stock indices and options on individual stocks and on stock indices) was possible. Starting from June 2000, derivatives have been introduced in the Indian stock markets. With the successful introduction of stock market derivatives, Indian stock markets now compare favourably even with the very best of the developed financial markets.




1) Point out the various supervisory functions of SEBI.

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2) List the novel practices introduced by the NSCCL that removed the counter-party risk from Indian stock markets.

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3) Summarise the impact of the radical reforms on the functioning of Indian stock markets.

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4) State whether following statements are True or False:

i) NSE is a de-mutualised stock exchange, but BSE has not yet adopted such a structure. ( )

ii) Novation helped in automating the stock market trading. ( )

iii) India currently follows a T+2 settlement cycle. ( )

iv) India currently has three depositories. ( )

v) Counter-party risk is absent in NSE. ( )

15.5 LET US SUM UP Indian securities markets had been suffering from some serious problems for over a century until the early 1990’s. The organisational structure of the stock exchanges and restrictive practices adopted by the members (i.e., the brokers), and lack of application of modern technology were responsible for these problems. Starting from 1993, wide-ranging reforms have been introduced in the Indian stock markets. The reforms were primarily concentrated on institution building and creation of world-class securities market infrastructure. Some innovative institutional structures and some innovative practices, with strong backing of the regulator (i.e., the SEBI), were responsible for success of the efforts at radically changing the Indian stock markets within a very short time span of less than a decade. Today, Indian securities markets are comparable with even the best of the markets in the developed world.

15.6 EXERCISES 1) Distinguish between money market and capital market. Examine the role

and significance of a well-developed capital market in the growth process of an economy.

2) Trace the development of capital market in India, listing the shortcomings it suffered from in the recent past and the reforms that have been undertaken.


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3) Discuss the functions of the SEBI. What has been the impact of the SEBI on the capital market in India?

15.7 KEY WORDS

Depository: A Depository is an organisation where the securities of an investor are held in electronic form. A Depository can be compared to a bank. In a bank, one has to open an account to deposit money and withdraw money already deposited. Similarly, an investor has to open an account, called demat account, with a depository (through a depository participant) to deposit his/her holding of securities in electronic form. A Depository Participant (DP) is an agent appointed by the Depository and is authorised to offer depository services to all investors. Like a bank statement, the DP provides the statement of transaction and holding for their demat account to the clients. Thus, the DP is basically the interface between the investor and the Depository.

All trading in shares is currently done on electronic trading platform where every transaction is recorded electronically. The ownership records of investors are maintained by the depositories. After an investor buys shares, the shares are deposited in the demat account, and he/she can sell those shares already held in the demat account.

Shares are actually held by the depositories, which become the legal owner of the shares held by them and the investors who have purchased the shares are the beneficiary owners. That is, all the benefits of owning shares accrue to the investors.

At present, India has only two depositories—National Securities Depository Ltd. (NSDL), promoted by the NSE, and Central Depository Services Ltd. (CDSL) promoted by the BSE. NSDL is the first Depository to have started in India.

Dematerialisation: Dematerialisation is a process in which your physical certificates get converted to securities in electronic form which is credited into the demat account (an account of the investor maintained with a depository participant) of the investor. To convert existing physical certificates, an investor needs to send the physical certificates along with a request to dematerialise to the depository through the depository participants. Dematerialisation offers several benefits:

• Paper-less holding of securities i.e. in electronic form, which enables buying and selling almost instantaneous.

• Risks associated with physical certificates (bad delivery, loss, mutilation or theft of share certificates, forgery, etc.) completely eliminated.

• No stamp duty and lower transaction costs for transfer of shares. • Reduced paper work. • Fast settlement cycles. • Automatic receipt of Corporate Actions (such as Initial Public Offer,

dividends, bonus shares, rights shares, etc.)

Rematerialisation is the process of converting back the dematerialised holdings to the physical certificate form. For rematerialisation, the investor needs to forward a request to the DP which will be verified for the balances held by the investor in the demat account and, in turn, will be forwarded to the Depository. The Depository, in turn, will forward the request to the Registrars and Transfer agents who will print the certificates and dispatch them to the investor.


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De-mutualisation: In India, all stock exchanges (except NSE) were set up as non-profit organisations. Among these, BSE, Ahmedabad Stock Exchange and Madhya Pradesh Stock Exchange were set as association of persons (AOP). Rest of the stock exchanges are companies. Corporatisation refers to the process of converting the organisational structure of the stock exchange from a non-corporate structure to a corporate structure. De-mutualisation, on the other hand, refers to the process of converting an exchange from a “mutually-owned” association to a company “owned by shareholders”. In other words, transforming the legal structure of an exchange from a mutual form to a business corporation form is referred to as demutualisation. The above in effect means that after demutualisation, the ownership, the management and the trading rights at the exchange are segregated from one another. This is not the case even for stock exchanges that have a corporate structure, because brokers themselves are owners as well as managers of these exchanges. Mutual exchange, the three functions of ownership, management and trading are interwined into a single group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. Demutualised exchange, on the other hand, has all these three functions clearly segregated, i.e. the ownership, management and trading are in separate hands. Currently, the National Stock Exchange (NSE) and Over the Counter Exchange of India (OTCEI) are not only corporatised but also demutualised with segregation of ownership and trading rights of members.

SEBI had constituted a Group on Corporatisation and Demutualisation of Stock Exchanges under the Chairmanship of Justice M H Kania, former Chief Justice of India, for advising SEBI on corporatisation and demutualisation of exchanges and to recommend the steps that need to be taken to implement the same. The Group had submitted its Report to SEBI on August 28, 2002. SEBI has taken up with Central Government to amend the SC (R) A to affect Corporatisation and Demutualisation. The amendment is to be introduced in the House of Parliament.

Market Capitalisation: Market capitalisation (MC) of a listed company is the product of the market price and the number of shares outstanding. It is taken as the market value of the listed company. Along with market price, the market capitalisation changes on a daily basis. The MC of the equity market of a country is the sum total of the MCs of all individual listed companies in that country. The equity market capitalisation as proportion of the country’s GDP, known as market capitalisation ratio, is an indicator of the size of equity market of the country. Market capitalisation of a company is an extremely important factor in investment decisions of institutional investors (FIIs, mutual funds, etc.). Many such investors do not even consider investment in stocks with market capitalisation below a certain level.

Turnover Ratio: The trading value (or turnover) of a listed company is defined as the number of shares of the company traded during a period (usually a year) multiplied by the price. The ratio of trading value to market capitalisation of the company, known as the turnover ratio, is an indicator of how active or liquid the company’s stock is. Similarly, the turnover ratio for the entire market is an indicator of liquidity of equity market in a country. For example, a turnover ratio of 1 (whether for a company or for a market) indicates that the entire market value (or market capitalisation) is traded once in a year. A low turnover ratio indicates lack of liquidity. If an investor purchases a low liquidity stock, he/she may find it difficult to sell simply


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because not enough buyers are available. Thus, most of the institutional investors avoid stocks with turnover ratio below a certain level.

Rolling Settlement: In a Rolling Settlement, all trades outstanding at end of the day have to be settled. That is, the buyers have to make payments for securities purchased and sellers have to deliver the securities sold. In India, rolling settlement was introduced with a T+5 settlement cycle effective from December 31 2001, which meant that a trade done on Day 1 had to be settled on the fifth working day after (excluding) the trading day. This was changed to the T+3 cycle effective from April 1, 2002, and T+2 cycle with effect from April 1, 2003, which is the current practice. Rolling settlement is a standard practice adopted in most developed countries.

Introduction of rolling settlement has stopped the practice of building the uncovered exposure by the brokers. Introduction of clearing corporation and novation and settlement guarantee fund have reduced the possibility of a payment crisis to almost nil. Not a single payment crisis has occurred so far in the NSE-NSCCL-NSDL system; crisis precipitated by the likes of Ketan Parikh and others after the mid-1990’s have occurred outside the NSE-NSCCL-NSDL system.

Short-Selling: Selling securities without owning them.


Patil, R.H. (2000); The Capital Market in 21st Century, Economic and Political Weekly, November, 2000.

Shah, A. and Thomas, S. (1997); Securities Markets, in K.S. Parikh, ed., India Development Report 1997, Oxford University Press, Chapter 10, pp. 167-192.

Shah, A. and Thomas, S. (2000); David and Goliath: Displacing a Primary Market, Journal of Global Financial Markets 1(1), 14-21.

Shah, A. (1999); Institutional Change on India’s Capital Markets, Economic and Political Weekly.

Waghmare, Tushar (1998); The Future of India’s Stock Markets, 1997, IIEF, New Delhi, XXXIV (3-4), 183-194.



1) See Section 15.2

2) See Section 15.3

3) i) True

ii) False

iii) True

iv) True

v) False

vi) True


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1) See Sub-section 15.4.1 under the head ‘The SEBI’.

2) See Sub-section 15.4.1 under the head ‘NSCCL’.

3) See Sub-section 15.4.2

4) i) True

ii) False

iii) True

iv) False

v) True

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