Development of Stock Markets

Table 2: Stock Market Indicators of Select Asian Markets

Country Market Capitalisation No of Listed Companies (in US $) Official 1981 1996 2004 1981 1996 2004 Liberalisation Date

India November 1992 6649 122605 386321 2114 2261 4730 Indonesia September 1989 74 91016 73251 8 253 331 Malaysia December 1988 10100 307179 181624 187 621 955 South Korea January 1992 4224 138817 389473 343 760 683 Thailand September 1987 N A 99828 115390 N A 454 463 Taiwan January 1991 5312 273608 441436 107 382 697

Source: Compiled from different issues of Annual Report, World Federation of Exchanges, S&P Emerging Stock Market Factbook.

Table 3: Stock Market Development, International Comparison, End 2003

US UK Japan Germany Singapore Hong Kong China India

Economic and Political Weekly May 6, 2006

market. The financial liberalisation added much-needed tempo to the development of the Indian stock market. It also brought about a series of changes, both quantitative and qualitative, in operational activities, which was not possible in the preliberalisation period. All stock market indicators that financial economists favour to measure the growth and development of the market, e g, market capitalisation, gross annual turnover, number of listed companies, P/E ratio, etc, started behaving well with the regime shift. Table 1 shows the pattern of changes of the Indian stock market with the gradual deregulation of the Indian economy.

This phenomenal change in the fortunes of the secondary markets in India has come about by the introduction of online trading, rolling settlement, electronic shares, and increased Foreign Institutional Investors (FIIs) participation. A comparative analysis of the experiences of select Asian emerging countries also confirms the view that financial liberalisation helped in the development of stock markets (Table 2). The recovery from the Mexican crisis of 1994 in emerging equity markets in 1996 was accompanied by increased liquidity in most markets as turnovers rose but new issuance remained subdued. The market capitalisation of emerging market countries has more than doubled over the past decade, growing from less than $ 2 trillion in 1995; it is set to exceed $ 5 trillion in 2006. As a percentage of world market capitalisation, emerging markets are now more than 12 per cent and steadily growing (Standard & Poor’s Global Stock Markets Factbook, 2005).

It is interesting to note that all the stock market indicators in India showed an increase up to 1999-2000 but nosedived afterwards. The reason for this fall after 1999-2000 could be the effects of the Mexican crisis in 1994, east Asian turmoil in 1997-98 and the global economic slowdown during 2000, all of which also affected the Indian market.

Moreover, to examine the impact of financial liberalisation on the size and liquidity of the stock markets, different stock market development indicators are available. To measure the size of the stock market, the market capitalisation ratio (MR), which equals the value of listed domestic shares on domestic exchanges divided by gross domestic products (GDPs), is one of the widely used indicators. Besides, to measure the stock market liquidity turnover ratio (TR) is important. The TR equals the value of trades of domestic shares on domestic exchanges divided by the value of listed domestic shares. The TR measures the volume of domestic equities traded on domestic exchanges relative to the size of the market. High turnover is often used as an indicator of low transaction costs. Levine (1996) argued that countries may be able to garner big growth dividends by enhancing the liquidity in their stock markets. Apart from these, the value traded ratio (VR) may also be considered to measure trading volume as a share of national output, and should therefore positively reflect liquidity on an economy-wide basis [Levine and Zervos 1998]. The VR is calculated by dividing the value of the trades of domestic shares on domestic exchanges by GDP. Table 1 shows that India’s MR was on the rise until 1999-2000 and, after a marginal fall, it recovered gradually. In comparison, TR showed a somewhat spectacular rise in the post-liberalisation era. But VR went through a roller-coaster ride. In the postliberalisation period, the Indian stock market especially now is comparable to many developed markets in terms of a number of parameters. The market capitalisation ratio compares favourably even with advanced countries and is much better than emerging markets. At the end of 2003, Standard and Poor’s (S&P) ranked India 17th in terms of market capitalisation, 16th in terms of total value traded in stock exchanges and 6th in terms of turnover ratio. There are very few countries that have a higher turnover ratio than India. India ranks second in the number of listed securities on the exchange after USA. The 142 Indian stocks, which accounted for 66.4 per cent of market capitalisation and 74.1 per cent of the total value traded, had a

5.78 per cent weight in International Finance Corporation (IFC) Global Composite Index of emerging market stocks. In the case of the IFC Investable Composite Indices, which include the emerging market stocks that are determined by the IFC to be legally and practically available to foreign portfolio investors, India’s share was only

2.31 per cent by the end of 2003 (Table 3).

Furthermore, a comparison of stock market operational indicators in India and select Asian countries also reveals some glaring facts. The average price-earning (P/E) ratio in the Indian market (BSE) was more than that of South Korea, Indonesia and Thailand, but quite below than that of Taiwan and Malaysia. Valuations for the Indian market are increasingly seen as being on the higher side, measured by their priceearnings ratios vis-à-vis Asian peers. From Table 4 it was also observed that as far as new capital raised, total market returns and average daily turnover, were concerned, the Indian market did extremely well as compared to its counterparts. But in terms of the average value of transactions and turnover velocity, the position of the Indian stock market was not at all encouraging (Table 4).

In the Indian context, in terms of high turnover and high liquidity in the secondary market, what is actually claimed may be far from true. Following policy reforms, the turnover in BSE has increased manifold, but out of the nearly 5,650 listed companies, the largest 500 companies in terms of market turnover account for about

Bombay Stock Exchange Sensitive Index (BSE Sensex) Year Mean Standard Skewness Kurtosis Deviation

1991 0.12 2.23 -1.09 9.19 1992 0.11 3.45 0.01 2.26 1993 0.08 2.11 -1.67 11.32 1994 0.07 1.44 0.57 1.99 1995 -0.15 1.32 0.00 0.35 1996 0.01 5.9 0.42 0.81 1997 0.03 1.68 -0.28 4.05 1998 -0.11 1.99 0.12 1.54 1999 0.19 1.82 0.60 2.24 2000 -0.12 2.22 -0.25 0.92 2001 -0.09 1.75 -0.50 1.76 2002 0.02 1.11 0.18 1.51 2003 0.24 1.18 -0.19 0.05 2004 0.04 1.61 0.16 1.63

Source: SEBI Monthly Bulletin, October 2004.

Table 4: Key Stock Market Indicators of Select Asian Markets*

India South Korea Taiwan Malaysia Indonesia Thailand

Economic and Political Weekly May 6, 2006 99 per cent of the turnover. Again, in the Indian stock market, out of nearly 7,000 listed stocks, as many as 4,000 are thinly traded or lack liquidity. The recent figures indicate that in 1999-2000, the percentage of non-traded scrips at BSE was 52.94. The percentage of non-traded scrips at the BSE rose to 65.46 per cent during 2004-05. Some other facts worth mentioning are that

8.8 per cent of the companies listed on the BSE traded for less than 10 days during 2002-03, while 32.2 per cent of the stocks were traded for less than 100 days. This highlights the fact that a handful of concentrated shares are being traded at high demand and, for the rest, the demand is either marginal or zero.

Considering all aforementioned stock market development indicators, it may be argued that domestically, financial liberalisation helped to develop the size and liquidity of the Indian stock market. However, in comparison to other developed and emerging stock markets, the Indian market is still lagging behind. The question that remains is how this development has helped to enhance the efficiency of the Indian stock market. Market efficiency is generally judged by the asset price volatility exhibited by a market. As already pointed out, Indian markets suffer from the menace of over-speculation and excessive price fluctuation that is more fierce than many of its counterparts. So, in the following section we seek to find out answers to some relevant questions: What is the impact of the regime shift on asset price volatility in Indian stock markets? What are the experiences of select Asian markets in this regard?

Share Price Volatility

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Economic and Political Weekly May 6, 2006

market underwent a volte-face overnight. Table 5 shows details of daily mean return, daily standard deviation, skewness and kurtosis for the Indian stock market over a 14-year period from 1991 to 2004. A close look at Table 5 reveals that India did show the highest volatility in 1992 at 3.45 per cent followed by 2.23 per cent in 1991 and recorded the lowest volatility in 2002 at 1.11 per cent, followed by 1.18 per cent in 2003, 1.32 per cent in 1995.

The daily average return and average volatility are useful to policy-makers, regulators, market participants and even investors. Furthermore, Indian market indices showed very high stability and normality. Both skewness and kurtosis are relatively low. In the years 1997 and 1998, the third and fourth order moments are comparatively low. Like other markets, India also experienced quieter moments from 1999 to 2003. It may be possible to conclude that the Indian market exhibited less asymmetry in the entire period [Raju and Ghosh 2004]. A comparison of return and volatility behaviour between India and select Asian countries are provided in Table 6.

From Table 6 it is evident that for 19841991, Indian market exhibited the highest volatility (1.97) with return 0.08, skewness negative and kurtosis 3.86. During the same period, all other Asian markets registered comparatively less volatility, but higher return. Interestingly, for 1992-2002 Indian market recorded a lower volatility than that of the previous time span with mean zero, negative skewness and higher kurtosis. Moreover, it is interesting to note that for whole time period 1984-2002, the Indian market exhibits a higher volatility than other countries with negative skewness and kurtosis being 4.66. Negative skewness and high kurtosis are extremely harmful to the investors in the long run. Traditionally, market watchers see the high volatility as a sign of investor nervousness which, in the counter-intuitive world of markets, is bullish. Conversely, low volatility is viewed as a sign of investor confidence or even complacency and the warning of a market downturn (ibid 2004). The higher expected returns on equity in emerging markets relative to mature markets have been associated with a generally higher price and return volatility. The volatility in emerging equity markets rose steadily during 1994 in the run-up to the Mexico crisis, plateauing at a considerably higher level during 1995. The volatility in Asian markets rose from 1.5 per cent in late 1993 to 3 per cent by mid-1995. Then volatility declined dramatically during the course of 1996 and continued doing so through May 1997, with that in Asia returning to its previous low of 1.50 per cent. By mid-1997 these volatilities were comparable to, and in fact, slightly below, those in the mature equity markets. This situation changed drastically in the second-half of 1997, as the volatility of returns on Asian emerging markets rose steeply. Global investors explore emerging markets in search of higher returns and also to reduce risk through portfolio diversification. However, cross-border flows entail a possible contagion in the event of financial turbulence.

Developed markets, in general, had less annualised volatility during 2004-05 compared to the volatility exhibited by emerging market economies. The highest volatility among developed markets was observed in Nasdaq (15.7 per cent) followed by Hang Seng Index (15.1 per cent) and the lowest volatility in AS30 Index of Australia (6.8 per cent). Among the emerging economies, Russia witnessed the highest annualised volatility of 36.4 per cent while Malaysia had the lowest volatility of 10.2 per cent.

Table 6: Return and Volatility Behaviour: Select Asian Countries

Source: SEBI Annual Report, 2002-03.

A comparative picture of annual returns on indices vis-à-vis annualised volatility is examined. It is evident from that among developed markets, with a low volatility of 6.8 per cent, Australia posted a healthy return of 20 per cent. However, Hong Kong with a volatility of 15.1 per cent could provide only a 6.6 per cent index return on a yearon-year basis. In emerging markets, the index returns trace a volatile pattern with the China SHCOMP index sliding by 32.2 per cent with an annualised volatility of

20.4 per cent. In case of India, both Sensex and Nifty posted positive returns of 16.1 and

14.9 per cent, respectively, with annualised volatility of 23.8 and 26.1 per cent. The correlation coefficient between volatility and annualised return from a sample of 19 countries worked out to be negative (–0.43) [SEBI Annual Report, 2004-05].

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Email: yojpeed@yahoo.co.in

References

Journal of World Business, Summer.