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Dr. S. Vijay Kumar
The Securities Contracts (Regulation)
Act, 1956, has defined Stock Exchange as an "association, organization or
body of individuals, whether incorporated or not, established for the purpose
of assisting, regulating and controlling business of buying, selling and dealing
in Securities". Stock exchange as an organized security market provides
marketability and price continuity for shares and helps in a fair evaluation of
securities in terms of their intrinsic worth. Thus it helps orderly flow and
distribution of savings between different types of investments. This
institution performs an important part in the economic life of a country,
acting as a free market for securities where prices are determined by the
forces of supply and demand. Apart from the above basic function it also
assists in mobilizing funds for the Government and the Industry and to supply a
channel for the investment of savings in the performance of its functions.
The Stock Exchanges in India as
elsewhere have a vital role to play in the development of the country in
general and industrial growth of companies in the private sector in particular
and helps the Government to raise internal resources for the implementation of
various development programmes in the public sector. As a segment of the capital
market it performs an important function in mobilizing and canalizing resources
which remain otherwise scattered. Thus the Stock Exchanges tap the new
resources and stimulate a broad based investment in the capital structure of
industries.
A well developed and healthy stock
exchange can be and should be an important institution in building up a
property base along with a socialist in India with broader distribution of
wealth and income. Thus Stock Exchange is a vital organ in a modern society. Without
a stock exchange a modern democratic economy cannot exist. The system of joint
stock companies financed through the public investment as emerged has put the
vast means of finances almost to entrepreneurs' needs.
Finance
from external sources mainly from the investing public can become possible only
when an institute like Stock Exchange provides opportunities for the conversion
of scattered savings into profitable investments with the promises of a
reasonable yield and minimum element of risk. Such a mechanism as provided by
Stock Exchanges is not merely a source of capital but also a conduit
which channelizes the savings into investment along with a free
movement of capital.
With the probable exception of a
totalitarian state no Government will be able to mobilize resources from the
public if the money market in the form of stock exchange does not exist. The
Stock Exchange benefits the entire community in a variety of way. It enables
the producers to raise capital which directly and indirectly gives gainful
employment to millions of people on the one hand and helps consumers to get;
the variety of goods needed by them on the other. It provides opportunities to
savers to store the value either as temporary abode of purchasing power or as a
permanent abode of purchasing power in the form of financial assets. It also
helps the segments of the savers who put their savings in commercial firms and
non-banking financial intermediaries because these institutions avail
themselves of the services of Stock Exchange to invest the money thus
collected.
The
Stock Exchange comes close enough to a perfectly competitive market allowing
the forces of demand and supply a reasonable degree of freedom to operate as
compared to other markets specially the commodity markets. This segment of the
factor market can be considered as a perfect or a nearly perfect market. Apart
from providing a mechanism for transacting business in stock and shares it
generates genuine potential for a new entrepreneur to take up initiative in the
private sector enterprises and allows the expansion of investing community by
offering gainful development of their otherwise sluggish or shy capital.
Stock Market (or stock exchange) is a place where stock (or shares as we
call in India)
is traded between investors at a particular price that is purely determined by
the demand and supply of the shares. For example, if the demand of the share is
greater than the supply, the price of the share will keep rising until the
demand is equal to supply. As a result the price of the share goes up.
Alternatively, if the supply of the share is more than the demand, the price of
the share falls till it equals demand. Normally
one would want to buy the shares of company that are performing good. This
would result in a rise in demand for the shares and the price will start
rising. The price will rise until the investors feel that the share price
correctly co relates with the good performance of the company. Similarly one
would try to sell shares of a company that is performing poorly and so the
supply will rise. The price will continue to fall till investors feel that the
price correctly correlates with the performance. It is worth noting that any
news that has an effect on the performance of the company will be reflected in
the price movement of the share. For example, if the government announces that
there is an upward revision in the price of petrol, the most likely gainers
will be companies like Indian Oil, BPCL, HPCL, ONGC, Reliance etc. Therefore,
their stocks (share prices) will start rising. Alternatively if the government
announces that there is no revision in the price of petrol even though the
price of crude is rising in the international market, the share prices of these
companies will be under pressure and will probably fall.
Now days shares are held in
dematerialized or demat form (i.e. in electronic form without any paperwork
involved) with a share broker who is registered with the stock exchange. In India, there are two main stock exchanges viz.
1) The Bombay
Stock Exchange (BSE)
2) The National Stock Exchange (NSE)
The Bombay Stock Exchange (BSE):
Bombay Stock Exchange, commonly referred to as the BSE is located at Mumbai. It is the 10th largest
exchanges in the
world by market capitalization.
Established in 1875, BSE formerly known as Bombay Stock Exchange Ltd. is Asia’s first Stock Exchange and one of India’s leading exchange groups. Over
the past 137 years, BSE has facilitated the growth of the Indian corporate
sector by providing it an efficient capital raising platform. BSE was also formerly known
as "The Native Share & Stock Brokers'
Association."
The National Stock Exchange (NSE):
National Stock Exchange of India
or in short NSE happens to be India’s largest Stock Exchange and world’s third
largest stock exchange in terms of transaction and 11th largest world's stock exchange in terms of market capitalization. It is located in Mumbai and
was incorporated in November 1992 as a tax-paying company. It was in April 1993
that NSE was recognized as stock exchange under the Securities Contract Act
1956.
Sensex and Nify:
The Sensex is an "index". It gives a general idea about
whether most of the stocks have gone up or down. It is an indicator of all the
major companies of the BSE. The Nifty is an indicator of all the major
companies of the NSE. Sensex consists of Big 30
Companies. Nifty consists of consists of 50 Big companies. There are lot of other companies besides the above said number.
Both the exchanges headquarters are at Mumbai. A broker can be a member
of either of the two or both. Time to time, the BSE
allocates weightage to different stocks that reflect their importance in the
stock markets. Take an example of two stocks RELAINCE and TATA POWER where both
are included in the Sensex. If the share price of Reliance goes up by Rs 10 and
the share price of TATA POWER falls by Rs 10, does it mean that they will
balance each other? The answer is no. This is because the weight of the
Reliance share is much more than Tata Power. In such a case the rise in the
Reliance share will out weigh the loss in Tata Power's share and the Sensex
will rise (assuming other stocks remain where they are). It is to be noted that
the Sensex will either move upwards or downwards only on the performance of
these 30 stocks (30 Companies shares value). Since the general mood of the
market is reflected by the movement in the Sensex, it remains in the news all
the time.
Characteristics or features of
stock exchange:
1. Market
for securities: Stock
exchange is a market, where securities of corporate bodies, government and
semi-government bodies are bought and sold.
2. Deals
in second hand securities: It
deals with shares, debentures bonds and such securities already issued by the
companies. In short it deals with existing or second hand securities and hence
it is called secondary market.
3. Regulates
trade in securities: Stock
exchange does not buy or sell any securities on its own account. It merely
provides the necessary infrastructure and facilities for trade in securities to
its members and brokers who trade in securities. It regulates the trade
activities so as to ensure free and fair trade.
4. Allows
dealings only in listed securities: In fact, stock exchanges maintain an official list of securities
that could be purchased and sold on its floor. Securities which do not figure
in the official list of stock exchange are called unlisted securities. Such
unlisted securities cannot be traded in the stock exchange.
5.Transactions
effected only through members: All
the transactions in securities at the stock exchange are affected only through
its authorized brokers and members. Outsiders or direct investors are not
allowed to enter in the trading circles of the stock exchange. Investors have
to buy or sell the securities at the stock exchange through the authorized
brokers only.
Functions of Stock Exchange:
1. Continuous and ready market
for securities:
Stock
exchange provides a ready and continuous market for purchase and sale of
securities. It provides ready outlet for buying and selling of securities.
Stock exchange also acts as an outlet/counter for the sale of listed
securities.
2. Facilitates evaluation of
securities:
Stock
exchange is useful for the evaluation of industrial securities. This enables
investors to know the true worth of their holdings at any time. Comparison of
companies in the same industry is possible through stock exchange quotations (i.e.
price list).
3. Encourages capital formation:
Stock
exchange accelerates the process of capital formation. It creates the habit of
saving, investing and risk taking among the investing class and converts their
savings into profitable investment. It acts as an instrument of capital
formation. In addition, it also acts as a channel for right (safe and
profitable) investment.
4. Provides safety and security
in dealings:
Stock
exchange provides safety, security and equity (justice) in dealings as
transactions are conducted as per well defined rules and regulations. The
managing body of the exchange keeps control on the members. Fraudulent
practices are also checked effectively. Due to various rules and regulations,
stock exchange functions as the custodian of funds of genuine investors.
5. Regulates company management:
Listed
companies have to comply with rules and regulations of concerned stock exchange
and work under the vigilance (i.e. supervision) of stock exchange authorities.
6. Facilitates public borrowing:
Stock
exchange serves as a platform for marketing Government securities. It enables
government to raise public debt easily and quickly.
7. Provides clearing house
facility:
Stock
exchange provides a clearing house facility to members. It settles the
transactions among the members quickly and with ease. The members have to pay
or receive only the net dues (balance amounts) because of the clearing house
facility.
8.
Facilitates healthy speculation:
Healthy
speculation, keeps the exchange active. Normal speculation is not dangerous but
provides more business to the exchange. However, excessive speculation is
undesirable as it is dangerous to investors & the growth of corporate
sector.
9. Serves as Economic Barometer:
Stock
exchange indicates the state of health of companies and the national economy.
It acts as a barometer of the economic situation / conditions.
10. Facilitates Bank Lending:
Banks
easily know the prices of quoted securities. They offer loans to customers
against corporate securities. This gives convenience to the owners of
securities.
Relation of the stock market to the modern
financial system:
The
financial system in most western countries has undergone a remarkable
transformation. One feature of this development is disinter-mediation A
portion of the funds involved in saving and financing, flows directly to the
financial markets instead of being routed via the traditional bank lending and
deposit operations. The general public interest in investing in the stock
market, either directly or through mutual funds has been an important component of
this process.
Statistics show that in recent
decades shares have made up an increasingly large proportion of households'
financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very
liquid assets with little risk made up almost 60 percent of households'
financial wealth, compared to less than 20 percent in the 2000s. The major part of this adjustment is that financial portfolios (portfolio means grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts) have gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds (Hedge funds are most often set up as private investment partnerships that are open to a limited number of investors (for super rich) and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies), insurance investment of premiums, etc. Portfolios are held directly by investors and/or managed by financial professionals.
The trend towards forms
of saving with a higher risk has been accentuated by new rules for most funds
and insurance, permitting a higher proportion of shares to bonds. Similar
tendencies are to be found in other industrialized countries. In all developed
economic systems, such as the European Union, the United
States, Japan
and other developed nations, the trend has been the same: saving has moved away
from traditional (government insured) bank deposits to more risky securities of
one sort or another.
Behavior of the stock market
From experience it is known that
investors may 'temporarily' move financial prices away from their long term
aggregate price 'trends'. (Positive or up trends are referred to as bull markets; negative or down trends are
referred to as bear markets). Over-reactions may occur—so that
excessive optimism (euphoria) may drive prices unduly high or excessive
pessimism may drive prices unduly low. Economists continue to debate whether
financial markets are 'generally' efficient.
According to one interpretation of
the efficient market hypothesis (EMH), only
changes in fundamental factors, such as the outlook for margins, profits or
dividends, ought to affect share prices beyond the short term, where random'noise'
in the system may prevail. For example, The stock
market crash in 1987, when the Dow Jones Index plummeted
22.6 percent—the largest-ever one-day fall in the United States demonstrated
that share prices can fall dramatically even though, to this day, it is
impossible to fix a generally agreed upon definite cause: a thorough search
failed to detect any 'reasonable' development that might
have accounted for the crash. (But, such events are predicted to occur strictly
by chance, although very rarely.) It seems also to
be the case more generally that many price movements (beyond that which are
predicted to occur 'randomly') are not occasioned by new information; a study
of the fifty largest one-day share price movements in the United States
in the post-war period seems to confirm this.
Other research has shown that psychological factors may result in exaggerated (statistically anomalous) stock price
movements (contrary to EMH which assumes such behaviors 'cancel out'). For
example - succession of good news items about a company may lead investors to
overreact positively (unjustifiably driving the price up). A period of good
returns also boosts the investor's self-confidence, reducing his
(psychological) risk threshold.
Another phenomenon—also from
psychology—that works against an objective assessment is group thinking. As social animals, it is not
easy to stick to an opinion that differs markedly from that of a majority of
the group. An example with which one may be familiar is the reluctance to enter
a restaurant that is empty; people generally prefer to have their opinion
validated by those of others in the group.
Irrational behavior of the Stock Market:
Sometimes, the market seems to react
irrationally to economic or financial news, even if that news is likely to have
no real effect on the fundamental value of securities itself. But, this may be
more apparent than real, since often such news has been anticipated, and a counter
reaction may occur if the news is better (or worse) than expected. Therefore,
the stock market may be swayed in either direction by press releases, rumors, euphoria and mass panic; but generally only briefly, as more
experienced investors (especially the hedge funds means fund of unregistered private
investment partnerships, who invest and trade in many different markets. Strategies
and instruments (including securities, non-securities and derivatives) are NOT
subject to the same regulatory requirements as mutual funds)
Over the short-term, stocks and other
securities can be battered or buoyed by any number of fast market-changing
events, making the stock market behavior difficult to predict. Emotions can
drive prices up and down, people are generally not as rational as they think,
and the reasons for buying and selling are generally obscure. Behaviorists
argue that investors often behave 'irrationally' when making investment
decisions thereby incorrectly pricing securities, which causes market
inefficiencies, which, in turn, are opportunities to make money. However,
the whole notion of EMH is that these non-rational reactions to information
cancel out, leaving the prices of stocks rationally determined.
International
portfolio flows: These
are commonly known as Foreign Institutional Investment (FII) flows; refer to
capital flows made by individual and institutional investors across national
borders with a view to creating an internationally diversified portfolio.
Unlike Foreign Direct Investment (FDI) flows which refer to that category of
international investment aimed at obtaining a lasting interest by a resident
entity in one economy in an enterprise resident in another economy by way of
exercising significant control over its management, FII flows are not directed
at acquiring management control over foreign companies. FII flows were almost
non-existent until 1980s. Global capital flows were primarily characterized by
syndicated bank loans in 1970s followed by FDI flows in 1980s. But a strong
trend towards globalization leading to widespread liberalization and implementation
of financial market reforms in many countries of the world had actually set the
pace for FII flows during 1990s. According to Bekaert and Harvey (2000), FII
investment as a proportion of a developing country's GDP increases
substantially with liberalization as such integration of domestic financial
markets with the global markets permits free flow of capital from
'capital-rich' to 'capital-scarce' countries in pursuit of higher rate of
return and increased productivity and efficiency of capital at global level. Diversifying
internationally i.e., holding a well-diversified portfolio of securities from around
the world in proportion to market capitalizations, irrespective of the
investor's country of residence, has long been advocated as the means to reduce
overall portfolio risk and maximize risk-adjusted returns by the classical capital
asset pricing model (CAPM). But a persistent 'home bias' (i.e., the tendency to
hold a greater proportion of stocks from the home country vis-à-vis the foreign
country) was noticed in the portfolios of investors in capital-rich industrialized
countries in early 1990s. With more and more emerging market economies (EMEs) deregulating
their financial markets by eliminating foreign exchange controls, reducing
taxes imposed on foreign investors, relaxing the restrictions on the purchase /
sale of securities by foreign investors in domestic markets etc., such 'home
bias' has decreased over the years.
Today, EMEs, by virtue of their lower correlations in stock
market returns with the developed markets, offer greater scope to investors in
developed countries to reduce their overall portfolio risk and effectively
enhance the portfolio performance and hence have become the most preferred
destinations for FII flows. Several research studies on FII flows to EMEs over
the world have highlighted that financial market infrastructure such as the
market size, market liquidity, trading costs, extent of information
dissemination etc., legal mechanisms relating to property rights etc., harmonization
of corporate governance, accounting, listing and other rules with those followed
in developed markets, and strengthening of securities markets' enforcement are important
determinants of foreign portfolio investments into emerging markets. Of late,
the Securities and Exchange Board of India (SEBI) and Reserve Bank of India
(RBI) have initiated a string of measures like allowing overseas pension funds,
mutual funds, investment trusts, asset management companies, banks,
institutional portfolio managers, university funds, endowments, foundations or
charitable trusts etc. but banning non-resident Indians (NRIs) and overseas
corporate bodies (OCBs) from trading as foreign portfolio investors, raising
the caps for FII from 24% to 49% of a non-bank company's issued capital subject
to sectoral caps / statutory ceiling as applicable, enhancing
the individual investment limit from 5% to 10% of issued capital, permitting
foreign investors to trade in Government securities and derivatives, easing the
norms for FII registration, reducing procedural delays, lowering fees,
mandating stricter disclosure norms, improved regulatory standards etc. with a
view to improving the scope, coverage and quality of FII flows into India.
As a result, India,
also supported by her strong economic fundamentals, has become one of the
attractive destinations for FII flows in the emerging market space today. The
expansionary effect of various reform measures on FII flows over the years can
be gauged from the fact that net (i.e., gross purchases minus gross sales) FII
flows into India have risen sharply from Rs. 5126 crore in 1993-1994 to Rs.
46,215 crore in 2004-2005, with the number of foreign institutional investors
being registered with SEBI increasing from 3 in 1993-1994 to 685 in 2004-2005
(Source : SEBI website). This increasing dominance of foreign investors in
Indian market has necessitated research on the implications of FII flows for
the Indian stock market time and again. Although FII flows help supplement the
domestic savings and augment domestic investments without increasing the
foreign debt of the recipient countries, correct current account deficits in
the external balance of payments' position, reduce the required rate of return
for equity, and enhance stock prices of the host countries, yet there are
worries about the vulnerability of recipient countries' capital markets to such
flows.
Dangers of FII flows: FII flows often referred to as 'hot
money' (i.e., short-term and overly speculative), are extremely volatile in
character compared to other forms of capital flows. Foreign portfolio investors
are regarded as 'fair-weather friends' who come in when there is money to be
made and leave at the first sign of impending trouble in the host country
thereby destabilizing the domestic economy of the recipient country. Often,
they have been blamed for exacerbating small economic problems in the host
nation by making large and concerted withdrawals at the slightest hint of
economic weakness. It is also alleged that as they make frequent marginal
adjustments to their portfolios on the basis of a change in their perceptions
of a country's solvency rather than variations in underlying asset value, they
tend to spread crisis even to countries with strong fundamentals thereby
causing 'contagion' in international financial markets.
Further, it
is feared that too much of FII inflows may build up sizable surpluses on a country's
balance of payments, create excess liquidity and hence exert upward pressure on
the exchange rate of the domestic currency or on domestic prices. The fear of
foreigners capturing a large part of the securities' market is also associated
with FII flows. Accordingly, it is viewed that as securities markets in
developing countries like India are narrow and shallow and as the foreign
investors have command over considerable funds and occupy a dominant position
in the capital market, FII flows have the potential for major capital flight out
of India driving the prices down sharply and hence inducing considerable
instability in the Indian stock market. The dangers of 'abrupt and sudden
outflows' inherent with FII flows have been highlighted in several research
studies. Capital Management crisis in September, 1998, have found evidences of
a strong negative effect on global capital flows, especially to emerging
markets. These crisis episodes have made the Indian policy makers all the more
wary about FII flows as questions have begun to be raised about the wisdom in
promoting such flows.
However,
the issue of whether FII flows affect stock market returns or the other way round
is a matter of some controversy. It has been perceived in some quarters that
FII flows are the major drivers of stock markets in India and hence a sudden reversal
of such flows may harm the stability of its markets. Contrary to this belief,
it is viewed by others that FII flows react to the existing crisis in the stock
market, possibly exacerbating it rather than causing it. An analysis of the
direction of causality to understand the possible devastating effect of volatility
of FII flows on the Indian economy is important from the viewpoint of Indian policy
makers especially when such flows have recorded a sharp rise over the last
decade.
Stock market and
Economy:
Stock market is an
important part of the economy of a country. The stock market plays a play a
pivotal role in the growth of the industry and commerce of the country that
eventually affects the economy of the country to a great extent. That is reason
that the government, industry and even the central banks of the country keep a close
watch on the happenings of the stock market. The stock market is important from
both the industry’s point of view as well as the investor’s point of view.
Whenever a company wants to raise funds for further expansion or
settling up a new business venture, they have to either take a loan from a
financial organization or they have to issue shares through the stock market.
In fact the stock market is the primary source for any company to raise funds
for business expansions. If a company wants to raise some capital for the
business it can issue shares of the company that is basically part ownership of
the company. To issue shares for the investors to invest in the stocks a
company needs to get listed to a stocks exchange and through the primary market
of the stock exchange they can issue the shares and get the funds for business
requirements. There are certain rules and regulations for getting listed at a
stock exchange and they need to fulfill some criteria to issue stocks and go
public. The stock market is primarily the place where these companies get
listed to issue the shares and raise the fund. In case of an already listed
public company, they issue more shares to the market for collecting more funds
for business expansion. For the companies which are going public for the first
time, they need to start with the Initial
Public Offering or the IPO.
In both the cases these companies have to go through the stock market. This is
the primary function of the stock exchange and thus they play the most
important role of supporting the growth of the industry and commerce in the
country. That is the reason that a rising stock market is the sign of a
developing industrial sector and a growing economy of the country.
Of
course this is just the primary function of the stock market and just an half
of the role that the stock market plays. The secondary function of the stock
market is that the market plays the role of a common platform for the buyers
and sellers of these stocks that are listed at the stock market. It is the
secondary market of the stock exchange where retail investors and institutional
investors buy and sell the stocks. In fact it is these stock market traders who
raise the fund for the businesses by investing in the stocks.
For
investing in the stocks or to trade in the stock the investors have to go
through the brokers of the stock market. Brokers actually execute the buy and
sell orders of the investors and settle the deals to keep the stock trading
alive. The brokers basically act as a middle man between the buyers and
sellers. Once the buyer places a buy order in the stock market the brokers
finds a seller of the stock and thus the deal is closed. All these take place
at the stock market and it is the demand and supply of the stock of a company
that determines the price of the stock of that particular company.
So
the stock market is not only providing the much required funds for boosting the
business, but also providing a common place for stock trading. It is the stock
market that makes the stocks a liquid asset unlike the real estate investment.
It is the stock market that makes it possible to sell the stocks at any point
of time and get back the investment along with the profit. This makes the
stocks much more liquid in nature and thereby attracting investors to
invest in the stock market.
Role
of Stock Markets in Economic Growth:
Dose the Stock market development play an important role for
economic growth in the developed and developing countries? Shahbaz et. al.
(2008) argues that stock market development is an important factor for economic
growth as there is a long-run relationship between stock market development and
economic growth. Stock market development has the direct impact in corporate
finance and economic development. Gerald (2006) states that stock market
development is important because financial intermediation supports the
investment process by mobilizing household and foreign savings for investment
by firms. It ensures that these funds are allocated to the most productive ways
and spreading risk and providing liquidity so that firms can operate the new
capacity efficiently. A growing body of literature has expressed the importance
of financial system to economic growth. Mish kin (2001) states that an organized
and managed stock market stimulate investment opportunities by recognizing and
financing productive projects and lead to economic activity, mobilize domestic
savings, allocate capital proficiency, help to diversify risks, and facilitate
exchange of goods and services. From the
view point of Sharpe, et al (1999) stock market is a mechanism through which
the transaction of financial assets with life span of greater than one year
takes place. Financial assets may take different forms ranging from the
long-term government bonds to ordinary shares of various companies. Stock
markets are the most important institutions in the capital market where the
shares of various companies are traded. Trading of the shares may take place in
two different forms of stock market. When the issuing company sells its shares
to the investors, the transaction is said to have taken place in the primary
market, when already issued shares of companies are traded among investors the
transaction is said to have taken place in the secondary market.
Stock
markets are very important because they play a significant role in the economy
by changing investment where it is needed and can be putted to best (Liberman
and Fergusson 1988). The stock markets are working as the channel through which
the public savings are mobilized to industries and business enterprises.
Mobilization of such resources for investment is certainly a necessary condition
for economic take off, but quality of their allocation to various investment
projects is an important factor for economic growth. This is precisely what an
efficient stock market does to the economy (Berthelemy and Varoudaks 1996).
During
nineteenth and twenty century, Bagehot (1973) and Schumpeter (1912) had focused
on the constructive assistance of financial sector to economic growth. In the
study, the direction of causality between the higher growth in financial sector
and country‘s economic growth rate was not clear (Robinson, 1952 and Lucas,
1988). Also, most of the traditional growth theorists believed that there is no
correlation between stock market development and economic growth because of the
presence of level effect not the rate effect. Similarly Singh (1997) contended
that stock markets are not necessary institutions for achieving high levels of
economic development. Many viewed stock market as a agent that harm economic
development due to their susceptibility to market failure, which is often
manifest in the volatile nature of stock markets in many developing countries
(Singh, 1997; Singh and Weis, 1999). So, the traditional assessment model of
stock prices and the wealth effect provide hypothetical explanation for stock
process to be proceeded as an indicator of output (Comincioli, 1996).
According to
wealth effect, however, changes in stock prices cause the variation in real
economy (Bhide, 1993; and Obstfeld, 1994). Contrary to traditional views; a
large number of theoretical and empirical works have been done in order to
understanding the strong positive linkage between stock market development and
economic growth. See for example likes Shahbaz, Ahmed and Ali (2008) has found
a long run relationship between stock market development and economic growth.
Stock market development has the direct impact in corporate finance and
economic development. Deb and Mukherjee (2008) have found a bi-directional
causality between real GDP growth rate and real market capitalization ratio in
the Indian Economy. Adjasi and Biekpe (2005) found a significant positive
impact of stock market development on economic growth in countries classified
as upper middle income economies. In the same way, Chen et al (2004) elaborated
that the nexus between stock returns and output growth and the rate of stock returns is a leading indicator of
output growth. Arestic et al (2001) using time series on five industrialized
countries also indicate that stock markets play an important role for economic
growth.
Conclusion: In the present LPG (Liberalization,
Privatization and Globalization) regime the stock market has been assigned to
play an important role in promoting capital accumulation and growth. But, the
Stock Exchange must assume the responsibility of protecting the rights of
investors specially the small investors in the Joint Stock Companies.
