Policy Issues in the Indian Securities Market

Market-oriented economic reforms in India began in 1991. With the removal of administrative controls on bank credit and the primary market for securities, the capital markets came to occupy a larger role in shaping resource allocation in the country. The efforts towards empowering the securities market regulator (SEBI), and the first efforts towards attracting foreign portfolio investment began early in the reform process. Almost immediately after the reforms began, there was a prominent scandal on the fixed income and equity markets, which was exposed in April 1992. This set the stage for an unusual policy intervention: the establishment of a securities exchange, the National Stock Exchange (NSE), by the government. Contrary to most expectations, NSE succeeded, becoming the largest equity market in 1995. NSE pioneered many important innovations in market design in India. The most important of these included nationwide electronic trading (1994), the clearing corporation as a central counterparty (1996) and paperless settlement at the depository (1996). The creation of the new exchange, clearing corporation and depository were important accomplishments of institution building. Yet, some important structural defects in market design persisted. Through this period, India's equity market was unique, by world standards, in featuring leveraged futures-style trading on the spot market. There was a mismatch between the extent of leverage, and the risk management and governance capacity found at securities exchanges and SEBI. In 2001, a major crisis broke on the equity market. This crisis was valuable in breaking a five-year deadlock and moving on with reforms.