Indian Economy, 5th edition (56 page)

Indian Capital Market

Money Market is the short-term financial market of an economy. In this market, basically, money is traded between individuals or groups (i.e., financial institutions, banks, government, companies, etc.) who are either
cash-surplus
or
cash-scarce
. The trading is done on a rate known as
discount rate
which is determined by the market and guided by the availability of and demand for the cash in the day-to-day trading
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. The ‘repo rate’ of the time (announced by the RBI) works as the guiding rate for the current ‘discount rate’. Borrowings in this market may or may not be supported by collaterals. In money markets, the
financial assets
which have quick conversion quality into money and carry minimal transaction cost are also traded
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. Money market may be
defined
as
a market where short-term lending and borrowing takes place between the cash-surplus and cash-scarce sides.

The market operates in both ‘organised’ and ‘unorganised’ ways in India. Starting from the ‘person-to-person’ mode converting into ‘telephonic transaction’ it has now gone
online
in the age of internet and information technology. The transactions might take place through the intermediaries (known as brokers) or directly between the trading sides.

Project Financing

After independence, India went for intensive industrialisation to achieve rapid growth and development. To this end, the main responsibility was given to the Public Sector Undertakings (PSUs). For industrialisation we require capital, technology and labour, all being typically difficult to manage for India. For capital requirement, the Government decided to depend upon internal and external sources to procure it. For rupee requirement of capital, the government decided to set up the financial institutions (FIs). To a limited extent FIs also served the foreign currency requirement (as in the case of the ICICI). Though India was having banks but due to low saving rate and lower deposits with them, the upcoming industries could not be financed. The main borrowers for industrial development were the PSUs. To support the capital requirement of the ‘projects’ of the public sector industries, the government came up with different types of financial institutions. The industrial financing supported by these financial institutions was known as project financing in India.

Financial Institutions

The requirement of project financing made India to go for a number of FIs from time to time which are generally classified into four categories
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:

1. All India Financial Institutions (AIFIs)

IFCI (1948); ICICI (1955); IDBI (1964); SIDBI (1990) & IIBI (1997). All of them were public sector FIs except the ICICI which was a joint sector venture with initial capital coming from the RBI, some foreign banks and FIs. The public sector FIs were funded by the Government of India.

By 1980s, all Indian banks had wider capital base and by early 1990s when the stock market became popular, it became easier for the corporate world to tap cheaper capital from these segments of capital market
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. The era of economic reforms had given the same option to the PSUs to tap new capital. As the AIFIs had more or less fixed rate of interest as compared to the banks which could mobilise cheaper deposits to lend cheaper—the AIFIs seemed to become irrelevant. The AIFIs witnessed a sharp decline in recent years.
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At this junction the Government decided to convert them into
Development Banks
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(suggested by the Narasimhan Committee-I) to be known as the All India Development Banks (AIDBs).

In 2000, the government allowed the ICICI to go for a
reverse merger
(when an elder enterprise is merged with a younger one) with the ICICI Bank – the first AIDB emerged with no obligation of project financing.

In a similar move, the IDBI was reverse merged with the IDBI Bank in 2002 and the second AIDB emerged. But it has still the obligation of carrying its project financing duties.

In 2004 (by the NDA Government), a proposal was discussed to allow a merger of the FIs merging the IFCI and IIBI with the nationalised bank PNB and thus would have emerged India’s first
Universal Bank
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. But the proposal is now almost sidelined with the political mandate changing at the centre.

Meanwhile, the GoI considers only
four
institutions as the AIFIs
regulated
by the RBI, viz. the EXIM Bank, NABARD, NHB and SIDBI. Rest of them have either become ‘development/universal banks’ or are under their process of ‘restructuring’ in the direct preview of the Ministry of Finance. In 2001-02, the GoI had tried to merge the IFCI and IIBI into the nationalised bank PNB to mark the beginning of a very big bank of international stature (in pursuant to the suggestions of the Narasimhan Committee-II following its 3-Tier Banking Structure of India). But the move could not materialise as the PNB probably backed out of the proposal (due to heavy due losses of these AIFIs)
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.

2. Specialised Financial Institutions (SFIs)
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Two new FIs were set up by the central government in the late 1980s to finance the risk and innovation in the area of industrial expansion. They were India’s first trial in the area of
venture capital
:-

(i)
Risk Capital and Financial Corporation Ltd (RCTC) set up in 1988

(ii)
Tourism Finance Corporation of India Ltd (TFCI) set up in 1989.

(iii)
IFCI Venture Capital Funds Ltd. (IFCI Venture) was promoted as a Risk Capital Foundation (RCF) in 1975 by the IFCI Ltd., a society to provide financial assistance to first generation professionals and technocrat entrepreneurs for setting up own ventures through soft loans, under the Risk Capital Scheme.

In 1988, RCF was converted into a company, Risk Capital and Technology Finance Corporation Ltd. (RCTC), when it also introduced the Technology Finance and Development Scheme (TFDS) for financing development and commercialisation of indigenous technology. Besides, under Risk Capital Scheme, RCTC started providing financial assistance to entrepreneurs by way of direct equity participation. Based on IFCI Venture’s credentials and strengths, Unit Trust of India (UTI), entrusted RCTC with the management of a new venture capital fund named
Venture Capital Unit Scheme (VECAUS-III)
in 1991 with its funds coming from the UTI and IFCI. To reflect the shift in the company’s activities, the name of RCTC was changed to IFCI Venture Capital Funds Ltd. (IFCI Venture) in February 2000.

In order to focus on Asset Management Activities, IFCI Venture discontinued Risk Capital and Technology Finance Schemes in 2000-01 and continued managing VECAUS-III. In 2007, as UTI had ceased to carry out its activities and its assets vested with
Specified Undertaking of the Unit Trust of India (SUUTI)
, the portfolio of VECAUS-III under management of IFCI Venture was transferred to SUUTI.

(iv)
The Government of India had, on the recommendations of the National Committee on Tourism (Yunus Committee) set up under the aegis of Planning Commission, decided in 1988, to promote a separate All-India Financial Institution for providing financial assistance to tourism-related activities/projects. In accordance with the above decision, the IFCI Ltd. along with other All-India Financial/Investment Institutions and Nationalised Banks promoted a Public Limited Company under the name of “Tourism Finance Corporation of India Ltd. (TFCI)” to function as a Specialised All-India Development Financial Institution to cater to the financial needs of tourism industry.

TFCI was incorporated as a Public Limited Company in 1989 and became operational with effect in 1989. TFCI was notified as a Public Financial Institution in January 1990. Its promoter, the IFCI, holds major share (41.6 per cent) in it while the rest of the shares are with the ‘public’ (26 per cent), public sector banks, public insurance companies and public mutual fund (i.e. UTI Mutual Fund Ltd.).

3. Investment Instituions (IIs)

Three investment institutions also came up in the public sector which are yet another kind of FIs i.e. the LIC (1956), the UTI (1964) and the GIC (1971).

In the present time they are no more considered as the FIs. The LIC is now the public sector insurance company in life segment, the GIC has been converted into a public sector re-insurance company and the UTI was converted into a mutual fund company in 2002.

Now these investment institutions (IIs) are no more like the past.The LIC is now called an ‘insurance company’, part of the Indian Insurance Industry and is the lone public sector playing in the life insurance segment. Similarly, the UTI is now part of the Indian Mutual Fund industry and the lone such firm in the public sector. This is why we do not get the use of the term ‘IIs’ in recent times in any of the GoI official documents.

4. State Level Finance Institutions (SLFIs)

In the wake of states involvement in the industrial development, the central government allowed the states to set up their own financial institutions (after the states demanded so). In this process two kinds of FIs came up:

(i)
State Finance Corporations (SFCs)
:
first coming up in Punjab (1955) and other states followed. At present there are 18 SFCs working

(ii)
State Industrial Development Corporations (SIDCs)
:
a fully dedicated state public sector FI to the cause of industrial development in the concerned states. First such FIs were set up (1960) in Andhra Pradesh and Bihar.

Almost all of the SFCs and SIDCs are at present running in huge losses.
t
hey may be re-structured on the lines of the AIFIs but there is lack of will from the states and private financiers who are not interested to go in for their takeovers as such.

Mutual Fund (MF)

Of all investment options, mutual funds are touted to be the best tool for wealth creation over the long term.They are of several types, and the risk varies with the kind of asset classes these funds invest in. As the name suggests, a mutual fund
7
is a fund that is created when a large number of investors put in their money, and is managed by professionally qualified persons with experience in investing in different asset classes – shares, bonds, money market instruments like call money, and other assets such as gold and property.
Their names usually give a good idea about what type of asset class a fund, also called a scheme, will invest in. For example, a
diversified equity fund
will invest in a large number of stocks, while a
gilt fund
will invest in government securities while a
pharma fund
will mainly invest in stocks of companies from the pharmaceutical and related industries.

Mutual funds are compulsorily registered with the Securities and Exchange Board of India
(Sebi),
which also acts as the
first wall of defence
for all investors in these funds. For those who do not understand how mutual funds operate but are willing to invest, the move by Sebi is seen as a big relief.

Each mutual fund is run by a group of qualified people who form a company, called an
asset management company (AMC)
and the operations of the AMC are under the guidance of another group of people, called
trustees.
Both, the people in the AMC as well as the trustees, have a
fiduciary responsibility
because these are the people who are entrusted with the task of managing the hard-earned money of people who do not understand much about managing money.

A fund house or a distributor working for the fund house (which could be an individual, a company or even a bank) are qualified to sell mutual funds. Once the fund house allots the ‘units’ of the MF to the investor at a price that is fixed through a process approved by Sebi which is based on the net asset value (NAV). In simple terms, NAV is the total value of investments in a scheme divided by the total number of units issued to investors in the same scheme. In most mutual fund schemes, NAVs are computed and published on a daily basis. However,when a fund house is launching a scheme for the first time, the units are sold at Rs 10 each.

There are
three types
of schemes offered by the MFs:

(i)
Open-ended Schemes:
An open-ended fund is the one which is usually available from a mutual fund on an ongoing basis, that is an investor can buy or sell as and when they intend to at a NAV-based price. As investors buy and sell units of a particular open-ended scheme, the number of units issued also changes every day and so changes the value of the scheme’s portfolio. So, the NAV also changes on a daily basis. In India,fund houses can sell any number of units of a particular scheme, but at times fund houses restrict selling additional units of a scheme for some time.

(ii)
Closed-ended Schemes:
A close-ended fund usually issue units to investors only once, when they launch an offer, called
new fund offer (NFO)
in India. Thereafter, these units are listed on the stock exchanges where they are traded on a daily basis. As these units are listed, any investor can buy and sell these units through the exchange. As the name suggests, close-ended schemes are managed by fund houses for a limited number of years, and at the end of the term either money is returned to the investors or the scheme is made open ended. However, there is a word of caution here that usually, units of close ended funds which are listed on the stock exchanges, trade at a high discount to their NAVs. But as the date for closure of the fund nears, the discount between the NAV and the trading price narrows, and vanishes on the day of closure of the scheme.

(iii)
Exchange-Traded Funds (ETFs):
ETFs are a mix of open-ended and close-ended schemes. ETFs, like close-ended schemes, are listed and traded on a stock exchange on a daily basis, but the price is usually very close to its NAV, or the underlying assets, like gold ETFs.