Financial markets: Looking ahead, while looking back

Financial markets, both in commodities and stocks, have flourished in India for almost a century and a half, but these markets actually witnessed a transformation only over the past two decades.

A little over 20 years ago, in 1992 to be precise, the Harshad Mehta scam shook the stock market. It was an event which verily transformed the securities market scenario in the country.

For, in the same year was incorporated the National Stock Exchange (NSE), which provided for the first time nationwide facilities for trading in securities through its electronic trading platform, as against the floor-based open outcry system that was hitherto prevalent among the stock exchanges spread across the country.

Establishment of SEBI

That year also saw the establishment of the Securities and Exchange Board of India (SEBI) under the SEBI Act, which was brought on the statute book just before. Through an amendment to the SEBI Act, in 1995, SEBI was not only made a statutory body, but was also empowered with quasi-legislative, quasi-judicial, and quasi-executive powers.

The rise of NSE as a national exchange led to the virtual elimination of as many as 21 regional stock exchanges; Bombay Stock Exchange survived, though. With the introduction of stock derivatives, options, and index futures during the past two decades however, the cash segment of the market began to languish. This was despite reforms like the settlement period for delivery and payment being reduced to just two days in 2003 from almost a week before. The introduction of derivatives and index futures, together with options, not only improved volumes in the securities market, but, more importantly, attracted fund inflows from abroad, and reduced volatility in securities market prices. Small surprise, India has firmly put its footprint on the global securities market map.

Meanwhile, MCX-Stock Exchange (MCX-SX) is set to enter the fray. It aims to spread the equity investment culture across the country in not only urban towns, but in rural areas also, where prosperity is on the rise.

MCX-SX has plans to penetrate into the equity segment in both cash and derivatives, offer bonds and interest rate derivatives and provide a platform for small and medium enterprises (SMEs) to raise capital too.

As with securities exchanges, commodity exchanges were virtually reinvented through the last two decades. Innovation in commodity derivative trading began following the introduction of electronic national commodity exchanges. In keeping with international trends, non-farm commodities overtook farm commodities on national exchanges, in line with the decline in the share of agriculture in the GDP of the nation. Multi Commodity Exchange of India Ltd (MCX), a metal and energy exchange, is now the largest in India and has also been recognised as the second largest commodity exchange in the world.

Unlike stock exchanges, which assist in channelising the savings of the society into productive investments for promoting economic growth, commodity exchanges aid physical market functionaries through the entire supply chain, from producers to processors and import–export traders, in both price discovery and price risk management.

It’s now time for the authorities to acknowledge the economic role and functions of commodity derivatives in both domestic and international trade. Paradoxical as it may seem, commodity trading in both soft and hard commodities as yet lacks adequate liquidity in comparison with its counterparts in the US and China.

What’s immediately called for is legalising options in commodities, allowing commodity index derivatives, and permitting the entry of banks to act as proxy hedgers or aggregators for producers and physical market functionaries who pledge their commodities with banks. That would not only enable banks to cut interest rates against commodity loans, but the resulting improvement in market depth and breadth would necessarily shrink marketing and processing margins to the benefit of both producers and consumers.

More reforms needed

While reforms in retail investment are, no doubt, desirable, much more necessary now are reforms in commodity derivative markets, which brook no further delay.

The Forward Contracts (Regulation) Amendment Bill is already pending in Parliament. Once it enters the statute book, the pre-independence golden age for commodity derivative markets is sure to dawn once again in the country.

A look ahead now clearly suggests that India is on the way to becoming the hub of financial markets, both for securities and commodities, in the world. Its march ahead is unstoppable, for sure.

(The author is Chairman, Financial Technologies Group. Views are personal)

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