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Global Financial Crises and Indian Capital Market: An Econometric Analysis

Article  in  International Journal of Applied Business and Economic Research · June 2012

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I J A B E R, Vol. 10, No. 1, (2012): 11-29

* Assistant Professor of Economics, Siksha O Anusandhan University, Bhubaneswar, Odisha, India,E-mail: pkmishra1974@gmail.com

GLOBAL FINANCIAL CRISES AND INDIAN CAPITALMARKET: AN ECONOMETRIC ANALYSIS

P. K. Mishra*

Abstract: In recent years, the World Economy has been experiencing a critical phase interms of decline in gross national products, rise in unemployment levels, and slump ininvestment activities. Such global scenario has affected the global growth and welfare. Theepicentre of these problems is the economic and financial crises of west. The crises originatedfrom deceptively small sources of west - sub-prime lending in the US in 2008 and governmentdebt in Greece in 2011. But, these crises have wobbled the backbone of the world economy.India being relatively integrated with and open to the global economy has been affected bythese crises. Currently, the national economy is passing through a phase of high inflation,exchange rate crisis, volatile capital market, discouraging investment scenario and increasein fiscal deficits. India has witnessed massive withdrawal of FII investments and subsequentcrash of the capital market due to global crisis. Since capital market segment has been affectedmuch by the global crises, this study is an attempt to examine the performance of the Indiancapital market in terms of market size, market liquidity, market turnover, market volatility,and market efficiency over the period 2008 to 2011. Although the capital market of Indiashowed relatively greater degree of volatility and weak form inefficiency during crises, thestudy found the evidence of the potential for increase in market size, more liquidity andreasonable market turnover. Therefore, the planners, policy makers and regulators shoulddevise prudential norms and implement fair market practices to make the national economymore resilient to cross border contagions.

Keywords: India, Capital Market, Performance Analysis, US crisis, Eurozone Crisis

JEL Classification Code: C10, C13, C51, G10, G14

I. INTRODUCTION

The beginning of 21st century can best be described as the period of economic andfinancial uncertainty. This period witnessed the first crisis with the burst of dotcom bubble in 2000 followed by US sub-prime crisis in 2007-08 and most recentlythe European debt crisis in 2011. After the dot com bubble burst in the US, monetarypolicy in US and other advanced economies was substantially eased. Policy ratesin the US reached one per cent in June 2003 and were held constant around thatlevels for an extended period up to June 2004. In the subsequent period, thewithdrawal of monetary accommodation was quite gradual. An empiricalassessment of the US monetary policy indicates that the actual policy during theperiod 2002-06, especially during 2002-04, was substantially looser than what asimple Taylor rule would have required. This was an unusually big deviation from

12 P. K. Mishra

the Taylor Rule1. In the post dot com period excessively loose monetary policyboosted consumption and investment in the US. With such low nominal and realinterest rates, asset prices recorded strong gains, particularly in housing and realestate, which provided further impetus to consumption and investment throughwealth effects. Thus, aggregate demand consistently exceeded domestic output inthe US and, given the macroeconomic identity, this was mirrored in large andgrowing current account deficits in the US over the period.

The large domestic demand of the US was met by the rest of the world, especiallyChina and other East Asian economies, which provided goods and services atrelatively low costs leading to growing surpluses in these countries. Sustainedcurrent account surpluses in some of these Emerging Market Economies (EMEs)also reflected the lessons learnt from the Asian financial crisis. Furthermore, theavailability of relatively cheaper goods and services from China and other EMEshelped to maintain price stability in the US and elsewhere, which might have notbeen possible otherwise. Thus, inflation rates in the advanced economies remainedlow which contributed to the persistence of accommodative monetary policy.

On account of this accommodative monetary policy dysfunctional globalimbalances emerged in the post 2000 phenomenon. Apart from creating large globalimbalances, accommodative monetary policy and the existence of very low interestrates for an extended period encouraged the search for yield, and relaxation oflending standards. The sustained rise in asset prices, particularly house prices, onthe back of excessively accommodative monetary policy and lax lending standardsduring 2002-2006 coupled with financial innovations resulted in a large rise inmortgage credit to households, particularly low credit quality households. Most ofthese loans were with low margin money and with initial low teaser payments.Due to the “originate and distribute2” model, most of these mortgages had beensecuritized. In combination with strong growth in complex credit derivatives andthe use of credit ratings, the mortgages, inherently sub-prime, were bundled into avariety of tranches, including AAA tranches, and sold to a range of financialinvestors of not only in USA, but also to the investors of Europe and Asia.

Financial innovations, regulatory arbitrage, lending malpractices, excessive useof the originate and distribute model, securitisation of sub-prime loans and theirbundling into AAA tranches on the back of ratings, all combined to result in theobserved excessive leverage of financial institutions. The excessive leverage on thepart of banks and the financial institutions (among themselves), the opacity of thesetransactions, the mounting losses and the dwindling net worth of major banks andfinancial institutions led to a breakdown of trust among banks. Given the growingfinancial globalization, banks and financial institutions in other major advancedeconomies, especially Europe, have also been adversely affected by losses and capitalwrite-offs. Inter-bank money markets nearly froze and this was reflected in veryhigh spreads in money markets.

Global Financial Crises and Indian Capital Market: An Econometric Analysis 13

As Europe was hit by the financial crisis of USA, many countries faced increasingwelfare spending. Ireland and Spain needed money to save their banks frombankruptcy. Unemployment was on the rise. And, the real estate boom, which hadtraversed to these countries as well, found it the suitable time to go bust. Tax receiptsthus collapsed. And, then Germany made the mistake of asking the bond holdersto share a part of the losses if the Government defaults. This spawned fear amongthe investors that European bonds were no safer. Investors started pulling out.This set off crashing bond prices, weakening banks and slowing growths.

The European countries like Greece and Italy, which were earlier consideredunreliable and having large current account deficits, got the chance of borrowinglarge amounts of money due to powerful Euro and lower interest rates and used itfor public spending prior to global financial crisis of 2008. But with the financialcrisis of 2008, the inflows became less and so did the tax receipts and Greece wasleft with a staggering amount of public debt. Then it went into the Debt crisis of2011.

Thus, excessively accommodative monetary policy for an extended period inthe major advanced economies in the post dot.com crash period sowed the seeds ofthe global financial crisis of 2008 and European debt crisis of 2011. In the context ofthese financial and economic crises, Indian economy can be looked to be relativelyinsulated. The global financial crisis got transmitted to India in January 2008 withthe beginning of a massive withdrawal of FII investments from Indian capital marketthat ultimately responsible for the capital market crash in India. Since in theaftermath of global financial crisis, capital market crash was the primary impact onIndia, it is imperative to examine the performance of Indian capital market in thepost crisis period. Furthermore, it is quite essential to make an investigation of theimpact of most recent Euro-zone debt crisis on the capital market of India.

It is with this backdrop, this paper is an attempt to examine the performance ofIndia’s capital market in the crises and post crises period. The rest of the paper isorganised as follows: Section II is an overview of India’s capital market; Section IIIis the review of related studies; Section IV is the discussion of data and methodologyof the study; Section V makes the analysis and discusses the findings; and SectionVI concludes.

II. OVERVIEW OF INDIA’S CAPITAL MARKET

Indian Capital market has witnessed a paradigm shift at par with the advancedmarkets of the world in the last two decades or so. Business process, functionality,monitoring/ regulating mechanisms, hardware, software etc., are all revamped tocompete with the global leaders. The current stand of Indian capital market has along history in its back. The history of the capital market in India dates back to theeighteenth century when East India Company securities were traded in the country.In 1850s, the trading was limited to a dozen brokers and their trading place was

14 P. K. Mishra

under a banyan tree in front of the Town Hall in Bombay. The location of tradingchanged many times, as the number of brokers constantly increased. The groupeventually moved to Dalal Street in 1874 and in 1875 became an official organizationknown as ‘The Native Share & Stock Brokers Association’. In 1895, this associationacquired a premise in the Dalal Street and it was inaugurated in 1899. Thus, the Stockexchange at Bombay was consolidated. And, the orderly growth of the capital marketin India began. The Bombay stock exchange got recognition in May 1927 under theBombay Securities Contracts Control Act, 1925. The constitution of India came intobeing on 26th January, 1950. The constitution put the stock exchanges and the forwardmarkets under the exclusive authority of the Government of India. In 1956, the BSEbecame the first stock exchange to be recognized by the Indian Government underthe Securities Contracts (Regulation) Act. The 1980s witnessed an explosive growthof the securities market in India, with millions of investors suddenly discoveringlucrative opportunities. Many investors jumped into the stock markets for the firsttime. The government’s liberalization process initiated during the mid-1980s, spurredthis growth. The Bombay Stock Exchange developed the BSE Sensex in 1986, givingthe BSE a means to measure overall performance of the exchange.

The 1990s will go down as the most important decade in the history of thecapital market of India. The Capital Issues (Control) Act, 1947 was repealed in May1992. The decade was characterized by a new industrial policy, emergence of SEBIas a regulator of capital market, advent of foreign institutional investors, euro-issues, free pricing, new trading practices, new stock exchanges, entry of new playerssuch as private sector mutual funds and private sector banks, and primary marketboom and bust. The 1991-92 securities scam revealed the inadequacies of andinefficiencies in the financial system. It was the scam, which prompted a reform ofthe equity market. The Indian stock market witnessed a sea change in terms oftechnology and market prices. Technology brought radical changes in the tradingmechanism. The Bombay Stock Exchange (BSE) was subject to nationwidecompetition by two new stock exchanges – the National Stock Exchange (NSE), setup in 1994, and Over the Counter Exchange of India (OTCEI), set up in 1992. TheNational Securities Clearing Corporation (NSCC) and National SecuritiesDepository Limited (NSDL) were set up in April 1995 and November 1996respectively form improved clearing and settlement and dematerialized trading.The Securities Contracts (Regulation) Act, 1956 was amended in 1995-96 forintroduction of options trading. Moreover, rolling settlement was introduced inJanuary 1998 for the dematerialized segment of all companies. With automationand geographical spread, stock market participation increased. In 1996, the NationalStock Exchange of India launched S&P CNX Nifty and CNX Junior Indices thatmake up 100 most liquid stocks in India. CNX Nifty is a diversified index of 50stocks from 25 different economy sectors. The Indices are owned and managed byIndia Index Services and Products Ltd (IISPL) that has a consulting and licensingagreement with Standard & Poor’s. In 1998, the National Stock Exchange of India

Global Financial Crises and Indian Capital Market: An Econometric Analysis 15

launched its web-site and was the first exchange in India that started trading stockon the Internet in 2000. The NSE has also proved its leadership in the Indian financialmarket by gaining many awards such as ‘Best IT Usage Award’ by Computer Societyin India (in 1996 and 1997) and CHIP Web Award by CHIP magazine (1999). In2000 the BSE used the sensitive index, i.e., Sensex to open its derivatives market,trading Sensex futures contracts. The development of Sensex options along withequity derivatives followed in 2001 and 2002, expanding the BSE’s trading platform.The introduction of rolling settlement system in all scrips and electronic fund transferin 2003 reduced the settlement cycle to T+2.

During the bull rally (2003-2007) there was considerable exuberance. This wasthe time when interest rates were low. Credit was available and that too cheaply.Not just that, corporate profits were growing at a healthy rate. Stock markets werenotching strong gains. Indian capital market in 2007-08, thus, features a developedregulatory environment, a modern market infrastructure, a steadily increasingmarket capitalization and liquidity, better allocation and mobilization of resources,a rapidly developing derivatives market, a robust mutual fund industry, andincreased issuer transparency.

But the global credit crisis of 2008-09 changed all that. The abundant liquidity,not surprisingly, led to asset bubbles that finally burst. Indian capital market hasseen its worst time with the global financial crisis. The most popular stock index,i.e., Sensex declined to its levels attained in December 2005. Similar decline hasalso been noticed for S & P CNX Nifty index. With the volatility in portfolio flowshaving been large during 2007 and 2008, the impact of global financial turmoil hasbeen felt particularly in the equity market. Indian stock prices have been severelyaffected by foreign institutional investors’ (FIIs’) withdrawals. FIIs had investedover Rs 10,00,000 crore between January 2006 and January 2008, driving the Sensex20,000 over the period. But from January, 2008 to January, 2009, FIIs pulled outfrom the equity market partly as a flight to safety and partly to meet their redemptionobligations at home. These withdrawals drove the Sensex down from over 20,000to less than 9,000 in a year. It has seriously crippled the liquidity in the stock market.The stock prices have tanked to more than 70 per cent from their peaks in January2008 and some have even lost to around 90 per cent of their value. This has left withno safe haven for the investors both retail and institutional. The primary marketgot derailed and secondary market was in the deep abyss.

Equity values were at very low levels and many established companies wereunable to complete their rights issues even after fixing offer prices below relatedmarket quotations at the time of announcement. Subsequently, market rates wentdown below issue prices and shareholders were considering purchases from thecheaper open market or deferring fresh investments. This situation naturally hadupset the plans of corporate houses to raise resources in various forms for theirambitious projects involving heavy outlays.

16 P. K. Mishra

Despite the scale down of popular capital market indices up to the first quarterof 2009, Indian stock markets then provide the evidence of strong resistance toglobal financial contagion. The year 2009-10 saw an upsurge in turnover on theexchanges, mainly on account of recovery of the global financial markets. Theturnover on the NSE rose by 50.36% in 2009-10 compared with 2008-09 and that onthe BSE it increased by 25.34% over the same period. The average daily turnoveron the NSE stood at US $ 3.5 billion in 2009-10 compared to US $ 2.0 billion in 2008-09. Though the average daily turnover on the BSE rose to US $ 1.1 billion in 2009-10from 0.89 billion in the previous year, it is still below the average daily turnover ofUS $ 1.6 billion recorded in 2007-08. As the trends in turnover showed a jump in2009-10 compared to 2008-09, the same was the case with market capitalization forsecurities available for trading on the equity segment of NSE and BSE. Afterwitnessing enormous growth during 2007-08 in comparison to 2006-07, 2008-09saw a fall in market capitalization followed by jump in 2009-10 over 2008-09 levels.The market capitalization of NSE, which as at end March 2008 amounted to INR48,581,217 million (US $ 1,215 billion), were down to INR 28,961,940 million (US $568 billion) on the NSE as at end March 2009. As at end September 2010, there hasbeen some increase in market capitalization to US $ 1,549 billion from US $ 1,255billion for NSE as at end of March 2010. This infers the strong investor confidenceand well risks diversification in Indian capital markets.

In 2009 the market was in a recovery mode; in 2010 it consolidated. Thefundamentals were strong. With average 8.9% growth in the first three quarters of2010 the economy is well poised to rush into 2011 with good performance. By thistime, consumer demand was strong, exports were rising and investment wasbuilding up. In 2010 stock prices increased 25% almost all the rise being in thesecond half of the year though corporate performance was better in the first half.The difference was the investment by FIIs to which the market is extremely sensitive.The RBI has estimated that a 10% fluctuation in FII investment results in a 35%variation in stock prices. In the first half of 2010 FII net investment was a mere Rs.300 billion; in the second five months it rose to Rs. 1010 billion.

The year 2010-11 has been another record year for the Indian capital marketswith 124 IPOs (Initial Public Offerings) and FPOs (Follow on Public Offerings) and41 QIPs (Qualified Institutional Placements). According to Bloomberg data, proceedsfrom fresh issues (IPOs) by Indian companies in 2010 surpassed even the levelsreached in 2007. The Government made a strong mark on the markets, raisingsignificant capital with string of IPOs and FPOs. Till March 2011, 124 IPOs hadaccounted for Rs. 51,000 crore (US$11.3 billion) in capital raised, averaging close toa billion dollar every month. This along with 41 QIPs that raised nearly Rs. 19,722crore (US$4.3 billion) meant that Indian companies rose more than Rs. 70,000 crore(US$15.5 billion) in the 2010-11 financial year.

It is, therefore, evident that the India’s capital market has shown good resilienceand quick recovery from the global financial meltdown. In this context, it is essential

Global Financial Crises and Indian Capital Market: An Econometric Analysis 17

that an empirical study be performed to examine the performance of the capitalmarket of India.

Performance of Indian Securities Market during 2000-2010

It can be seen that during the decade, there has been a significant rise in the marketcapitalization ratio, turnover ratio and traded value ratio. The turnover in the cashmarket has nearly doubled over the decade while the market capitalization hasbecome eight times the levels that existed in 2000.

Figure 1: All India Market Capitalization Ratio and Turnover Ratio

The turnover in the Indian derivatives market has increased from US $ 0.086trillion in 2000-01 to US $ 3.92 trillion in 2009-10 and has surpassed the cash marketturnover in India. The resource mobilization in the primary market has increaseddramatically, rising six fold between 2000 and 2010. Similarly, the resourcemobilization through euro issues has increased significantly over the years. Theperformance of the Indian capital market has been impressive with high returnsand a high level of investment from both domestic and foreign investors.

III. RELATED STUDIES

There has been a wide range of studies performed in the financial economicsliterature concerning the Indian capital market. Several studies such as Sahni (1985),Kothari (1986), Mookerjee (1988), Lal (1990), Ramesh Gupta (1991,1992),Raghunathan (1991), Gupta (1992), and Sinha (1993) comment upon the Indiancapital market in general and trading systems in the stock exchanges in particular.Raju and Ghosh (2004) empirically observe that emerging capital markets exhibithigher intra-day volatility compared to developed markets. It is a sign of anemerging market owing to economic and socio-political variations; the volatility in

18 P. K. Mishra

Figure 2: Growth in All India Equity Market Turnover and Market Capitalization (USD mn)

Figure 3: Resource Mobilization in Primary Market (USD mn)

Figure 4: Resource Mobilization through Euro Issues (USD mn)

Global Financial Crises and Indian Capital Market: An Econometric Analysis 19

the emerging markets is generally on the high side. Chakrabarti and Mohanty (2005)discuss how capital market in India is evolved in the reform period.

Bajpai (2006) concludes that the capital market in India has gone through variousstages of liberalisation, bringing about fundamental and structural changes in themarket design and operation, resulting in broader investment choices, drasticreduction in transaction costs, and efficiency, transparency and safety as alsoincreased integration with the global markets. The opening up of the economy forinvestment and trade, the dismantling of administered interest and exchange ratesregimes and setting up of sound regulatory institutions have enabled time. Mishra

Figure 5: Net Investment by FIIs and Mutual Funds in USD mn)

Figure 6: Equity Derivatives Turnover (USD mn)

20 P. K. Mishra

et al. (2010) studied the performance of Indian capital market for the period 2002 to2009 and provides the evidence of greater volatility and weak form inefficiency ofthe market. The market also shows strong potential for greater market size, moreliquidity and reasonable market turnover ratio. Mishra and Pradhan (2009) studiedthe efficient market hypothesis in the context of Indian equity market for the period2001 to 2009 and provided the evidence of weak form inefficiency of Indian capitalmarket over the sample period.

Prasad and Reddy (2009) examined the impact of global financial crisis on Indiaand observed that the combination of a rapid sell off by financial institutions andthe prospect of economic slowdown have pulled down the stocks and commoditiesmarket in India. Suresh (2010) studied the impact of financial crisis on Indian capitalmarket in arena of financial innovations and concluded that financial stability inIndia has been achieved through perseverance of prudential policies which preventinstitutions from excessive risk taking and financial markets from becomingextremely volatile and turbulent which boosted investors confidence. Mall andMishra (2012) attempted to make a post-mortem of the crises of west and impactson Indian economy. The study suggested that there should be effective supervisionof all financial activities, both private and public, if the country is to be crisis resilient.Karmakar and Mishra (2012) provided a comprehensive picture of global financialand economic crises and their impacts on India. Sahoo and Sethi (2012) examinedthe impact of current global financial crisis on Indian economy and found that incomparison to the advanced capitalist countries of the west, India has not muchaffected by this crisis.

This literature review brings into forefront the fact that the capital marketliterature lacks the empirical study of the performance of the Indian capital market,especially in the aftermath of global financial crisis. Therefore, in this paper anattempt has been made to study empirically the performance of Indian capitalmarket and enrich the literature in this direction.

IV. DATA AND METHODOLOGY

Indian capital market is truly an emerging market as it is significant in terms of thedegree of development, volumes of trading and in terms of its tremendous growthpotential. Thus, this study uses the parameters like market size, market liquidity,market turnover, market volatility, and market efficiency to gauge the performanceof Indian capital market. This paper assumes the two leading stock exchanges ofIndia, namely, Stock Exchange, Mumbai and National Stock Exchange, India as theproxies for Indian capital market. All the relevant data have been gathered fromthe publications of RBI, NSE India, and SEBI and from the websites of BSE India,NSE India, RBI, and SEBI. The sample period of the study spans from January 2002to December 2011. The study uses the techniques of trend analysis to analyse thegrowth pattern of India’s capital market in terms of market size, liquidity, andturnover over the sample period.

Global Financial Crises and Indian Capital Market: An Econometric Analysis 21

The study further uses the Threshold GARCH (1,1) model to capture the timevarying volatility of India’s capital market. The volatility modelling uses daily stockreturns data based on closing Sensex for BSE and Nifty for NSE over the sampleperiod from Jan 2008 to December 2011. This period is significant to include thesub-prime crisis of US and Debt crisis of Euro zone. The performance of BSE Sensexand S & P CNX Nifty can be observed for the sample period from Fig. 7.

Figure 1: Movements in BSE Sensex and NSE Nifty(From Jan 2008 to Dec 2011)

It is inferred that the stock price indices in India’s equity market shows adownturn till the first quarter of 2009 due to the impact of Global Financial crisisthat originated from US sub-prime crisis in 2008. However, Indian capital marketshowed an incredible resilient and recovered from the beginning of FY 2009. Thebull rally continues till December 2010. Thereafter, the indices witnessed largervolatility and bearish trend, particularly due to the activities of FIIs and panic ofEuro Zone crisis of 2011. This is the reason why we have selected this sample periodfor analysing the performance of India’s capital market.

First, the daily stock returns (Rt) are calculated by the log difference change in

the price index:−

=

1

log tt

t

PR

P where Rt is the daily stock return at time ‘t’ and Pt

and Pt–1 are the closing value of the stock price Indices at time ‘t’ and ‘t–1’respectively. Then, the Threshold GARCH (1,1) model has been estimated toinvestigate whether good or bad news contributes to the volatility of Indian capitalmarket. The specification for conditional variance (volatility) in Threshold GRACH(1, 1) model is:

− − −σ = ω+ α + γ ε + βσ2 2 21 1 1( )t t t tR

22 P. K. Mishra

Here, the dummy variable It–1 is an indicator for negative innovations and isdefined by: It–1 = 1, if εt–1 < 0 and It–1 = o if εt–1 ≥ 0. In this model, good news, εt–1 > 0,and bad news, εt–1 < 0, have differential effects on the conditional variance; goodnews has an impact of α, while bad news has an impact of α + γ. If γ > 0, then badnews increases volatility, and we say that there is a leverage effect. If γ ≠ 0, the newsimpact is asymmetric.

The study also examines the weak form efficiency of India’s capital market toobserve the effectiveness of the information flow. In this study, the non-parametrictest as suggested by Phillips and Perron (1988) is performed to examine theinformational efficiency of Indian capital market. The Phillips and Perron (PP)method estimates the following equation:

−∆ = α + δ + ε'1t t t tR R x & α = ρ – 1

Where, Rt is the quarterly Sensex based stock market return, xt are optionalexogenous regressors which may consist of constant, or a constant and trend, ρ areδ parameters to be estimated, and, εt are assumed to be white noise. The null andalternative hypotheses of this test are H0 : α = 0 (existence of unit root or non-stationarity) vs. H1 : α < 0

V. EMPIRICAL ANALYSIS AND DISCUSSION

This paper embarks upon the empirical study of the performance of Indian capitalmarket taking into account the analysis of the parameters like market size, marketliquidity, market turnover, market volatility, and market efficiency over the sampleperiod of 2002-11 by examining the annual, and the daily data.

(A) Market Size

The size of a capital market as measured by stock market capitalization is positivelycorrelated with the ability to mobilise capital and diversify risk on an economy-wide basis. The size of the Indian capital market can be assessed by employing thestock market capitalisation to GDP ratio Levine and Zervos (1998). This size ratioof Indian capital market is shown in Table 1.

Table 1Market Size (BSE and NSE)

Year Size Ratio (BSE) % Size Ratio (NSE) %

2002-03 23.31 21.882003-04 43.60 40.692004-05 53.92 50.342005-06 84.41 78.572006-07 85.50 81.222007-08 109.00 103.072008-09 139.44 130.212009-10 131.59 125.592010-11 136.86 133.47

Global Financial Crises and Indian Capital Market: An Econometric Analysis 23

It has been observed that the market size of Indian capital market is increasingover the years except in 2009-10. This year’s decline in market size is the effect ofglobal financial crisis on Indian capital market. Thus, the overall indication is thatin India the size of capital market is expanding which is the signal for strong potentialof the market to mobilise capital for the economic development of the country.

(B) Market Liquidity

Market Liquidity refers to the ability to buy and sell securities easily. Liquid capitalmarket allows companies on the one hand, to have a permanent access to capitalthrough equity issues and on the other hand, to allow investors to switch out ofequity if they need to access funds or if they want to change the composition oftheir portfolios. The market liquidity is measured by the ratio of total value ofshares traded to GDP. The liquidity ratio in Indian capital market is shown inTable 2.

Table 2Market Liquidity (BSE and NSE)

Year Liquidity Ratio (BSE) % Liquidity Ratio (NSE) %

2002-03 14.16 27.872003-04 20.91 45.762004-05 19.93 43.822005-06 28.71 55.222006-07 30.67 62.402007-08 46.45 104.482008-09 33.43 83.642009-10 39.92 119.832010-11 23.10 74.79

The above table infers that the market liquidity of Indian capital market issomewhat less during 2008-09 and 2010-11. This is reflection of the impact of globalslowdown on Indian capital market. However, the overall performance of the ratioindicates that the Indian capital market is liquid and in particular the liquidity ofNSE India is quite higher than that of Stock Exchange, Mumbai. The ratioperformance of 2009-10 and 2010-11 is also appreciable for the National stockExchange.

(C) Market Turnover

The market turnover gives the total value of shares traded in relation to the size ofthe market. It is the most important indicator of market activity. It is calculated asthe ratio of total value of shares traded to the market capitalisation. The turnoverratio is also the indication of market liquidity. This ratio for Indian capital marketis shown in Table 3.

24 P. K. Mishra

Table 3Market Turnover (BSE and NSE)

Year Turnover Ratio (BSE) % Turnover Ratio (NSE) %

2002-03 54.88 115.052003-04 41.84 98.082004-05 30.54 71.902005-06 27.00 55.792006-07 26.97 57.762007-08 30.72 73.092008-09 23.97 64.232009-10 30.34 95.412010-11 16.88 56.03

It is very clear from the Table 3 that the turnover ratio in Indian capital marketis oscillatory. Particularly, the performance of the ratio in BSE is disappointing.The low levels of turnover ratio in BSE can be interpreted as the low levels of tradingactivities in comparison to NSE. High turnover ratio of NSE may be due to itstransparency, technological sophistication, and after all may be due to the efficientpayment and settlement framework.

(D) Market Volatility

Market volatility is the degree to which asset prices tend to fluctuate. Volatility isthe variability or randomness of asset prices. Volatility is often described as therate and magnitude of changes in prices and in finance often referred to as risk.This research focuses particularly on time series volatility behaviour in Indian capitalmarket during January 2008 to December 2011. The objective is, thus, to investigatethe volatility characteristics of the Indian capital market measured by fat tail,volatility clustering, and leverage effects. The descriptive statistics pertinent to thereturn series so defined for Indian capital market are summarized in Table-4.

Table 4Descriptive Statistics of Return series

Statistics BSE NSE

Mean -0.000277 -0.000294Standard Deviation 0.019876 0.019899Skewness 0.294216>0 0.165514>0Kurtosis 9.563975>3 10.80170>3Jarque-Bera Statistic 1777.094 with probability zero 2451.747 with probability zero

The measure of kurtosis suggests that the daily stock return series in Indiancapital market have fatter tails than the normal distribution over the sample period.That is, the probability of extreme returns that has been observed empirically ishigher than the probability of extreme returns under the normal distribution. This

Global Financial Crises and Indian Capital Market: An Econometric Analysis 25

is termed as Lepto-kurtosis, or simply ‘fat tails’. The daily stock returns series are,thus, not normally distributed – a conclusion which is confirmed by the Jarque-Bera (JB) test. The existence of fat tails indicates the time varying volatility of theIndian capital market.

Now to test the volatility clustering in Indian capital market, the daily stockreturn series based on closing values of Sensex and S & P CNX Nifty over thesample period have been plotted as shown in Figure 7. It is apparent in the figurethat the amplitude of daily stock returns is changing in Indian capital market. Themagnitude of this change is sometimes large and sometimes small. This sort ofeffect is called volatility clustering. And, this volatility is higher when stock pricesare falling than when prices are rising. It means that the negative returns are morelikely to be associated with greater volatility than positive returns. This is calledasymmetric volatility effect. It is also evident that the volatility was relatively moreduring July 2008 to March 2009, and then volatility is substantially less till December2010. The year 2011 shows greater degrees of volatility but not as evidenced tillMarch 2009. The greater degree of volatility during July 2008 to March 2009 wasdue to global financial meltdown, and the relatively smaller degree of volatility in2011 may be due to FII activities and the threat of euro area crisis. This indicatesrelatively lesser impact of 2011 economic crisis on Indian stock markets than thatof the 2009 global financial crisis.

Figure 7: Movements in BSE Sensex and NSE Nifty Based Daily Returns(From Jan 2008 to December 2011)

But to concretely draw any inference about the event whether good news orbad news that increases volatility in Indian capital market, the regression based onThreshold GRACH(1,1) model has been estimated for the said sample period. Theresults are reported in Table 5 & 6.

26 P. K. Mishra

Table 5T-GARCH (1, 1) Estimates of Daily Stock Returns based on Sensex

Coefficient Std. Error z-Statistic Prob.

ω 3.01E-06 1.11E-06 2.719807 0.0065α 0.048443 0.011524 4.203579 0.0000γ 0.132748 0.024846 5.342792 0.0000β 0.885906 0.014765 59.99881 0.0000

It shows that the good news has an impact of 0.048443 magnitudes and the badnews has an impact of 0.048443+0.132748 = 0.181191 magnitudes in the Stockexchange, Mumbai.

Table 6T-GARCH (1, 1) Estimates of Daily Stock Returns based on CNX Nifty

Coefficient Std. Error z-Statistic Prob.

ω 9.37E-06 1.52E-06 6.165392 0.0000α 0.047171 0.014299 3.298883 0.0010γ 0.159716 0.027845 5.735838 0.0000β 0.858543 0.018242 47.06526 0.0000

It shows that the good news has an impact of 0.047171magnitudes and the badnews has an impact of 0.047171+0.159716= 0.206887 magnitudes in the NationalStock exchange of India.

Thus, it is inferred that in the Indian capital market, the bad news increases thevolatility substantially. Also, this time varying stock return volatility is asymmetric.The change in the pattern of volatility and the recent irregular behaviour of thestock market came as a result of the global economic events, particularly the globalfinancial crisis of 2008 and most recent Euro area economic crisis. This study showsthat crises have created an unprecedented high level of volatility during 2008-09and could explain to some degree the recent sluggish performance of the market.

(E) Market Efficiency

The term ‘market efficiency’ is used to explain the relationship between informationand share prices in the capital market literature (Mishra, 2009) and Mishra et al,2009). An efficient capital market is commonly thought of as market in which securityprices fully reflect all relevant information that is available about the fundamentalvalue of the securities. Fama (1970) defines an efficient market as a market in whichprices always reflect the recent available information and states that three differentlevels of efficiency exist based on what is meant as ‘available information’ – theweak, semi-strong, and strong forms. Weak form efficiency exists when security pricesreflect all the information contained in the history of past prices and returns. If

Global Financial Crises and Indian Capital Market: An Econometric Analysis 27

capital markets are weak-form efficient, then investors can not earn super-normalprofits (excess profits) from trading strategies based on past prices or returns.

Therefore, stock returns are not predictable, and hence follow a random walk.Under semi-strong form efficiency, security prices reflect all publicly availableinformation. Investors, who base all their decisions on the information that becomespublic, cannot gain above-average returns. Under strong form efficiency, allinformation - even apparent company secrets – is incorporated in security pricesand thus, no investor can earn excess profit by trading on public or non-publicinformation. The objective of this part of the study is testing the weak form efficiencyin Indian capital market. And, we used the most popular unit root test to cater theneed. In the class of unit root test, the Phillips-Perron Test is considered mostpowerful to examine whether Indian capital market is efficient in its weak-form ornot. The results of this test for a sample period from January 2008 to December2011 as applicable to BSE and NSE are summarized in Table 7.

Table 7Results of Phillips-Perron Unit Root Test

Indian capital Market PP Unit Root Test Statistic with Intercept

Stock Exchange, Mumbai -29.03488 < -3.436796 at 1% level with Prob.=0National stock Exchange -29.41640 < -3.436796 at 1% level with Prob.=0

Clearly, the null hypothesis of unit root in the series of index based daily returnsis rejected in the capital market of India at 1% level of significance. Thus, Indiancapital market is not efficient in its weak form. This market inefficiency is anindicative of sub-optimal allocation of portfolios into capital market of India. Fromthe perspective of investors, the weak form inefficiency can provide an opportunityfor earning supernormal profits.

V. CONCLUSION

In recent years, the World Economy has witnessed two important crises – the GlobalFinancial Crisis that originated from the US sub-prime crisis in 2008 and mostrecently the Euro Zone crisis that initiated from the Debt Crisis of Greece in 2011.These crises have wobbled the backbone of the world economy in terms of declinein gross national products, rise in unemployment rates, adverse exchange ratescenario, and slump in the rate of capital formation. Although the epicentre of criseswas west, many developed and developing nations have been the victims of theseproblems. And, India is no exception. The crises mainly transmitted to India throughfinancial and trade channels. Since India is more integrated with the world financialmarkets, particularly with international capital markets, the crises immediatelyresulted in increase in market volatility, slump in trading volume, and plunge ininvestors’ confidence. Thus, the capital market of India crashed after massive

28 P. K. Mishra

withdrawals by domestic and foreign investors. Despite, Indian economy showedan appreciable resilience in terms of rapid revitalization of macroeconomicindicators. Regarding the Eurozone crisis, India has been least affected. It is withthis backdrop, this paper attempted to make an empirical appraisal of theperformance of the Indian capital market in terms of the key market parametersincluding size ratio, liquidity ratio, turnover ratio, market volatility, and marketefficiency. The study provides the evidence of growing market size, liquidity, greatervolatility and weak form inefficiency. In this context, it may be suggested that theplanners, policy makers and regulators should make the national economy morerobust by devising, through market reforms, the prudential norms and internationalbest and fair practices. It is at least learnt that ‘slow and steady win the race’, butnot the ‘Rabbit Run’.

Notes1. In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank

should change the nominal interest rate in response to changes in inflation, output, or othereconomic conditions. In particular, the rule stipulates that for each one-percent increase ininflation, the central bank should raise the nominal interest rate by more than one percentagepoint. This aspect of the rule is often called the Taylor principle.

2. ‘Originate and distribute’ is the practice under which a bank does not hold the loans that itoriginates, but distributes them to other financial institutions after they have been repackagedand converted into bonds by securitization.

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