Unit 2
Indian Financial System : Monetary And Fiscal
Policy,Economic Trends, Price Policy,Stock Exchange
Of India,Role of regulatory instituions in Indian
financial system – RBI and SEBI , National
Income,Role of Industry in Economic Development,
Foreign Trade and Balance of Payment,Poverty in
India, Unemployment in India, Inflation, Human
Development, Rural Development, Problems of
Growth
1-2
Stock Exchange
(Meaning
)
• Stock exchange constitute the primary institution of
the secondary market. The stock exchange is a
highly organized market for the purchase and
sale of second-hand quoted or listed securities.
Thus the stock exchange is a key institution
facilitating the issue and sale of various types of
securities.
• There are 21 stock exchange in India including Over
The Counter Exchange of India(OTCEI), National
Stock Exchange (NSE), and Inter-Connected Stock
Exchange(ICSE).
Stock Exchange
(Definition)
• According to Securities Contracts (Regulation) Act,
1956, Stock exchange means(a) Any body of individual, whether incorporated or not,
constituted before corporatization and demutualization
under sections 4A and 4B or
(b) A body corporate incorporated under the Companies Act,
1956 whether under a scheme of corporatization or
otherwise, for the purpose of assisting, regulating or
controlling the business of buying, selling or dealing in
securities.
Contd.
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According to this Act, securities include the
following:
Shares, scrips, stock, bonds, debentures, debenture
stock or other marketable securities of a like nature of
any incorporated company or body corporate.
Derivative
Units or any other instrument issued by any collective
investment scheme to investors in such schemes
Government securities
Rights or interest in securities
Functions of Stock Exchange
• Ready and continuous market
• Protection to investors
• Provides information to assess the real worths of
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securities
Proper channelization of funds
Promotion of industrial growth
Accelerates capital formation
Raising long-term capital
Impact on company performance
Economic barometer
Importance
of
Stock
Exchange
• The stock exchange promotes industrial and
economic growth.
• The stock exchange is one of the basic financial
tools for stimulating the economy by attracting
capital for investment in the projects.
• The stock exchange also helps to revive other
sectors of the economy such as commerce,
industry and service.
• Stock exchange is providing a market that
mobilizes and distributes the nation' savings
utilized for the best purpose of the country.
Contd.
 The opportunity for stock exchange to render the
services of stimulating private savings and
channelizing such savings into productive investment.
• It ensures optimum utilization of scarce financial
resources.
• The listed companies on the stock exchange enjoy
better reputation, goodwill and credit-standing in the
market.
• The stock exchange is attracting foreign capital to
the country.
• Stock exchange enables a company to raise
Contd.
larger amount of funds through accessing a
wider market.
• The communication of information about the
prices of different securities enables the investors
to make sound investment decisions.
• It provides liquidity to investors as securities can
be converted into cash without any difficulty.
• The interests of investors are safeguard by
regulations imposed by the stock exchange
authorities
Organization
of stock Exchange
The working of stock exchange is regulated by the Securities Contracts
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(Regulation) Act, 1956. it frames out following organization of stock
exchangeManagement: the stock exchange is managed by an Board of
Directors/Council of management/Governing body which is an
elected body. The main functions of governing body are to ensure that
its rules are observed by the members, to protect the interests of the
investing public and to approve the quotation of new shares.
Membership
Listing of securities
Types of dealings: Ready delivery contracts & Forward delivery
contracts
Clearing house : this is an institution where accounts of the brokers
are settled.
Speculation and Speculators: Speculation refers to making quick
profits by anticipating the changes in the prices of shares
Speculators are of three types- bulls, bear and Stags
NATIONAL STOCK EXCHANGE
(NSE)
NATIONAL STOCK EXCHANGE
(NSE)
 The NSE was established in November,1992 by IDBI, UTI and other
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financial institutions to encourage stock exchange reform through
system modernization and competition.
It is the 9th largest stock exchange in the world by market
capitalization (around US$1.59 trillion) and largest in India by daily
turnover and number of trades, for both equities and derivative
trading.
NSE's key index is the S&P CNX Nifty, known as the NSE NIFTY
NSE is the third largest Stock Exchange in the world in terms of the
number of trades in equities.
It is the second fastest growing stock exchange in the world
(NSE) contd.
 It is an electronic screen based system where members
have equal access and equal opportunity of business
irrespective of their location in different parts of the
country as they are connected through a satellite network.
 The NSE is to operate in two segments as outlined below:
(a) Wholesale Debt Market: is concerned with trading
instruments such as Gilt edge securities, commercial
papers, PSU Bonds, units and Certificate of Deposits.
(b) The Capital Market : is concerned with equity and
corporate debt instruments.
NSE (Advantages)
 It establishes nationwide trading facility for equity,
debt and hybrid.
 It facilitates equal access to investors across the
country.
 It provides fairness, efficiency and transparency to the
securities trading.
 It enables shorter settlement cycles.
 It meets international securities market standard.
BOMBAY STOCK EXCHANGE (BSE)
(BSE)
contd.
 The Bombay Stock Exchange (BSE) is a stock
exchange, located on Dalal Street, Mumbai, India.
 The BSE developed the BSE Sensex in 1986, giving the
BSE a means to measure the overall performance of the
exchange.
 Historically an open-cry floor trading exchange, the BSE
switched to an electronic trading system in 1995.
 In 2000 the BSE used this index to open its derivatives
market, trading Sensex futures contracts. The
development of Sensex options along with equity
derivative followed in 2001 and 2002, expanding the BSE’s
trading platform.
BSE (contd.)
 The BSE is the oldest stock exchange in Asia and has the
third largest number of listed companies in the world,
with 4900 listed as on Feb,2010.
 On Feb, 2010, the equity Market Capitalization of the
companies listed on the BSE was US$1.28 trillion, making
it the largest stock exchange in South Asia and the 12th
largest in the world.
 With over more than 5459 Indian companies listed &
more than 8000 scrip's on the stock exchange, it has a
significant trading volume.
Why do we need a regulatory body for Investor
protection in India?
India is an ` informationally ' weak market
Boosting capital market demands restoring the
confidence of lay investors who have been beaten
down by repeated scams
Progressively softening interest rates and an under
performing economy have eroded investment options,
and require enhanced investing skills.
SEBI - Genesis
 To ensure effective regulation of market, SEBI Act, 1992
was enacted to empower SEBI with statutory powers for
protecting the interests of investors in and promoting
the development of securities market.
 According to section 3 of the Act, SEBI is a body
corporate having perpetual succession and a common seal
with power to acquire, hold and dispose of property, both
movable and immovable and to contract, sue and be sued
in its own name.
Objectives of SEBI
 Securities & Exchange Board of India (SEBI) formed
under the SEBI Act, 1992 with the prime objective of
– Protecting the interests of investors in securities,
– Promoting the development of, and
– Regulating, the securities market and for matters connected
therewith or incidental thereto.’
Focus being the greater investor protection, SEBI has
become a vigilant watchdog
SEBI – Constitution & Organization
Chapter II of the Act deals with establishment of SEBI and its
management. SEBI has its Head Office in Mumbai and has powers to
establish its offices at other places in India. SEBI presently has offices
also in KolKata, New Delhi, and Chennai.
Section 4(1) of SEBI Act provides that SEBI Board shall consists of the
following members, namely:
a) A Chairman;
b) Two members from amongst the officials of the Ministry of the
Central Government dealing with Finance and administration of the
Companies Act, 1956;
c) One member from among the officials of the Reserve Bank of India
(RBI);
d) Five other members of whom at least three shall be the whole time
members,
to be appointed by the Central Government.
Contd.
 The Chairman and the other members are from amongst
the persons of ability, integrity and standing who have
shown capacity in dealing with problems relating to
securities market or have special knowledge or experience
of law, finance, economics, accountancy, administration or
in any other discipline as specified by CG.
 The terms and conditions of service of Chairman and
members are determined in the rules framed by CG in this
regard.
 The general superintendence, direction and management
of the affairs of SEBI vests in a Board of members.
FUNCTIONS OF SEBI
Chapter IV of the SEBI Act, 1992 deals with the powers and
functions of the Board. Some of them are as follows:

(A) Regulation Of Business In The Stock Exchanges
A review of the market operations, organizational structure
and administrative control of the exchange
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All stock exchanges are required to be Body Corporates
The exchange provides a fair, equitable and growing
market to investors.
The exchange’s organisation, systems and practices are in
accordance with the Securities Contracts (Regulation)
Act (SC(R) Act), 1956
Functions – contd.
B) Registration And Regulation Of The Working Of
Intermediaries
Primary Market
Secondary Market
Merchant Bankers
Stock brokers
Underwriters
Sub- Brokers
Portfolio Managers
•regulates the working of the depositories [participants], custodians of
securities, foreign institutional investors, credit rating agencies (like
CRISIL)and such other intermediaries
Functions – contd.
C)
Registration And Regulation Of Mutual Funds, Venture
Capital Funds & Collective Investment Schemes
 AMFI-Self Regulatory Organization-'promoting and
protecting the interest of mutual funds and their unitholders, increasing public awareness of mutual funds,
and serving the investors' interest by defining and
maintaining high ethical and professional standards in the
mutual funds industry'.
 Every mutual fund must be registered with SEBI and
registration is granted only where SEBI is satisfied with
the background of the fund.
 SEBI has the authority to inspect the books of accounts,
records and documents of a mutual fund, its trustees,
AMC and custodian where it deems it necessary
Functions – contd.
D) Promoting & Regulating Self Regulatory
Organizations (The Microfinance Institutions Network
(MFIN), a self-regulatory body, initiated by RBI
– In order for the SRO to effectively execute its
responsibilities, it would be required to be structured,
organized, managed and controlled such that it retains its
independence, while continuing to perform a genuine
market development role
E) Prohibiting Fraudulent And Unfair Trade
Practices In The Securities Market
– SEBI is vested with powers to take action against these
practices relating to securities market manipulation and
misleading statements to induce sale/purchase of securities.
Functions – contd.
F] Prohibition Of Insider Trading
– Stock Watch System, which has been put in place, surveillance over
insider trading would be further strengthened.
G] Investor Education And The Training Of Intermediaries
– SEBI distributed the booklet titled “A Quick Reference Guide for
Investors” to the investors
– SEBI also issued a series of advertisement /public notices in national as
well as regional newspapers to educate and caution the investors about
the risks associated with the investments in collective investment
schemes
– SEBI has also issued messages in the interest of investors on National
Channel and Regional Stations on Doordarshan.
Functions – contd.
H)
Inspection And Inquiries
I)
Regulating Substantial Acquisition Of Shares And Take-overs
J)
Performing Such Functions And Exercising Such Powers
Under The Provisions Of The Securities Contracts
(Regulation) Act, 1956 As May Be Delegated To It By The
Central Government;
K)
Levying Fees Or Other Charges For Carrying Out The
Purposes Of This Section
L)
Conducting Research For The Above Purposes
Search & Seizure and Penalty
 To impose penalties of up to Rs 25 crore or three times the
amount involved in the violation of a norm, whichever is
higher. (e.g. In case of insider trading)
 In the cases of some offences, including defaults by brokers, a
failure to furnish returns and information by corporates and
brokers and other lapses, the market regulator can impose a
higher penalty of Rs 1 lakhs a day or a maximum fine of Rs 1
crore, whichever is lower.
 At present, the offences carry penalties ranging between Rs
5,000 and Rs 5 lakhs.
RESERVE BANK OF INDIA
( RBI)
RESERVE BANK OF INDIA
(RBI)
Establishment :
 Reserve Bank of India (RBI) is the central bank of the country. It was
established in April 1, 1935 in accordance with the provisions of the
Reserve Bank of India Act, 1934 with a share capital of Rs. 5 crores
on the basis of the recommendations of the Hilton Young
Commission. The share capital was divided into shares of Rs. 100
each fully paid which was entirely owned by private shareholders in
the beginning. The Government held shares of nominal value of Rs.
2,20,000. RBI has been fully owned by the Government of India since
nationalization in 1949.
Contd.
 It’s headquarter is in Mumbai.
 RBI is governed by a central board (headed by a
Governor) appointed by the Central Government. The
current governor of RBI is Raghuram Rajan
 RBI has 22 regional offices across India.
 There are 16 departments of RBI.
 It has a majority stake in the State Bank of India.
OBJECTIVES
 To promote monetization and monetary
integration of the economy.
 To manage currency and regulate foreign
exchange.
 To institutionalize saving through promotion of
banking habit.
 To build up a sound and adequate banking and
credit structure.
 To evolve a well differentiated structure of
institutions purveying credit for agriculture and
allied activities.
Organization Structure of RBI
 The organization structure of the RBI consists of the Central Board of Directors and the
Local Board of Directors.
Central Board of Directors
 Consists of 20 members consisting of Governor and 4 Deputy Governors appointed by
the Government of India for a period of five years.
 Four directors are nominated by the Central Government, one each from the four Local
Boards situated at Mumbai, Kolkata, Chennai and New Delhi.
 Ten directors nominated by the central government are the experts drawn fro various
fields appointed for four years.
 The 20th member of CBD is a government official who is usually the Secretary, “Ministry
of Finance” nominated by the central Government.
 The final control vests with the Central Board of Directors.
 Functions of CBD : General superintendence and direction of
Bank’s affairs.
The Local Board of Directors
 Consists of four from Mumbai, Kolkata, Chennai and New Delhi.
 The local Board of Directors' will be assisted by four members each
nominated by the Central Government for a term of four years.
 And these local boards will advise the Central Board of Directors.
 A Committee of Central Board of Directors consists of Governor,
Deputy Governor and Directors as may be present in the meeting.
 Functions of LBD : to advise the CBD on local matters and to
represent territorial and economic interests of local cooperative and
indigenous bank; to perform such other functions as delegated by CBD
from time to time.
FUNCTIONS OF RBI
 Note Issuing Authority
 Banker to Government
 Bankers’ Bank
 Supervising Authority
 Exchange Control Authority
 Promoters of the Financial System
Role
of
Reserve
Bank
of
India
 To maintain monetary stability.
 To maintain financial stability.
 To maintain stable payments system (e.g. RTGS)
 To promote the development of financial
infrastructure of markets and systems.
 To ensure that credit allocation should reflect the
national economic priorities and societal concerns.
 To regulate the overall volume of money and credit
in the economy.
Monetary Policy
(Meaning & Definition)
 Monetary policy is that instrument which is used to control
the volume of money and credit in the economy. In other
words, it is the policy of the government executed by the
medium of the central bank to control the availability, cost
and use of money and credit with the help of monetary
measures in order to achieve predetermined economic
objectives.
 According to Harry G. Johnson, monetary policy is a
“policy employing the central bank’s control of the supply
of money as an instrument for achieving the objective of
general economic policy”.
 Thus monetary policy is meant to regulate the supply of
money and credit.
Monetary Policy
(Objectives)
The main objectives of monetary policy are:
 Price stability
 Exchange stability
 Healthy balance of payments
 High rate of economic growth
 Controlled Expansion Of Bank Credit
 Promotion of Fixed Investment
 Restriction of Inventories
 Promotion of Exports and Food Procurement
Operations
Types of Monetary Policy
 Contractionary Monetary Policy : tends to curb
inflation by contracting the money supply.
 Expansionary Monetary Policy : tends to encourage
growth by expanding the money supply especially in
the phase of recession.
Instruments/Techniques of Monetary
Policy
 There are two types of instruments of monetary policy in India:
Instruments of Monetary Policy
Quantitative (or General)
Bank Rate
Open Market operations
Cash reserve ratio (CRR)
Statutory liquidity ratio(SLR)
Repo Rate(Repurchase Price)
Reverse Repo Rate
Selective (or Qualitative)
Credit Rationing
Margin requirements
Regulation of Consumer credit
Direct Action
Discriminationary Interest Rate
Moral Suasion
Repo Rate
 Repo rate or repurchase rate is the rate at which banks
borrow money from the central bank (RBI for India)
for a short period by selling their securities (financial
assets) to the central bank with an agreement to
repurchase it at a future date at predetermined price. It
is similar to borrowing money from a money-lender by
selling him something, and later buying it back at a
pre-fixed price.
Reverse Repo Rate
 Reverse Repo rate is the rate of interest at which the
central bank (RBI) borrows funds from other banks for
a short duration. The banks deposit their short term
excess funds with the central bank and earn interest on
it.
SLR
 Statutory liquidity ratio (SLR) refers to the amount
that the commercial banks require to maintain in the
form of gold or govt. approved securities before
providing credit to the customers. Here by approved
securities we mean, bond and shares of different
companies. Statutory Liquidity Ratio is determined
and maintained by Reserve Bank of India in order to
control the expansion of bank credit.
Cash Reserve Ratio
 Cash Reserve Ratio is a specified minimum fraction
of the total deposits of customers, which commercial
banks have to hold as reserves with the central bank.
Highlights of Monetary policy
as on July 15, 2014
 Bank Rate 9.00%
 Repo Rate 8.00%
 Reverse Repo Rate 7.00%
 Cash Reserve Ratio (CRR) 4%
 Statutory Liquidity Ratio (SLR) 22.00%
Fiscal policy
( Meaning & Definition)
Fiscal Policy may be defined as that part of governmental
economic policy which deals with taxation, public expenditure,
borrowing and the management of public debt in an economy.
 According to Arther Simithies , “fiscal policy is a policy under
which government uses its expenditure and revenue programme
to produce desirable effects and avoid undesirable effects on the
national income, production and employment”.
 According to Paul Samuetson, “ Fiscal Policy means Public
expenditure and tax policy”.
Characteristics of Fiscal Policy in
India
 Rationalization of Product Classification Codes
 Common accounting year for Income Tax
 Long Term Fiscal Policy
 Reliance on Indirect Taxes
 Introduction of MODVAT
 Inadequate Public Sector Contribution
Objectives of Fiscal Policy
The Fiscal Policy or Budgetary Policy in India is
designed to achieve the following objectives:
 To achieve desirable price level
 To achieve plan targets of employment
 To reduce regional imbalances
 To reduce concentration of income and wealth
 To modify industrial structure
 To achieve rapid economic development
Three possible stances of fiscal policy
 A neutral stance of fiscal policy implies a balanced
budget where G = T (Government spending = Tax
revenue).
 An expansionary stance of fiscal policy involves
government spending exceeding tax revenue (G > T).
 A contractionary stance of fiscal policy occurs when
government spending is lower than tax revenue(G <
T).
Instruments of Fiscal Policy
 Budget
 Policy of Taxation
 Policy of Public expenditure
 Policy of Public debt management
Instruments of Fiscal Policy- contd.
(A) Budget : There are two parts of the Budget 1. Revenue
Budget:- Taxation is the main source of income and
examples of revenue expenditure are expenditure incurred
on Police and Judiciary system, administration expenditure,
govt. office expenditure etc.
2. Capital Budget :- Internal borrowings (e.g. from RBI) &
External borrowing (e.g. WTO, IMT, IFC etc.) form the
source of income and capital expenditure are construction
of dam, roads, highways, building etc.
(B) Policy of Taxation: ( Direct Tax – Income and wealth
tax & Indirect Tax – Excise duty, custom duty, Sales tax etc.)
Instruments of Fiscal Policy –
contd.
 Policy of Public expenditure: are of two types –1.
Development Expenditure – which enhances the
productivity & efficiency and of lasting nature e.g.
construction dam, roads, highway, ports etc. & which
enhance knowledge and skills e.g. hospital and education
facilities)
2. Non-Development Expenditure - expenditure incurred
on Police and Judiciary system, administration expenditure,
govt. office expenditure, defense etc.
 Policy of Public debt management: Internal & External
Borrowings
Advantages of Fiscal Policy
 Capital formation
 Resource mobilization
 Incentive to Private Sector
 Reduction in Inequality of Income and Wealth