The more liberalized a securities market is, the better is its impact on economic growth. Interventions in the securities market were originally designed to help governments expropriate much of the seigniorage and control and direct the flow of funds for favoured uses. These helped governments to tap savings on a low or even no-cost basis. In some economies governments used to allocate funds from the securities market to competing enterprises and decide the terms of allocation. The result was channelisation of resources to favoured uses rather than sound projects. In such circumstances accumulation of capital per se meant little, where rate of return on some investments were negative while extremely remunerative investment opportunities were foregone. This kept the average rate of return from investment lower than it would otherwise have been and, given the cost of savings, the resulting investment was less than optimum. This led mainstream development economists to argue that liberalization of securities market is the road to higher levels of domestic savings/investment and more efficient allocation of capital.

The implication of intervention is illustrated in figure 1. The vertical axis represents cost of capital and rate of return on investment and the horizontal axis represents the amount of capital raised from the securities market. With intervention, the demand for investment is represented by DdD, which indicates lower average rate of return corresponding to suboptimal resource allocation. As the level of investment increases to OD, the maximum permitted by the authorities, the average rate of return decreases as relatively less remunerative investments are approved. SS represents the supply of capital. This results in an investment of K. If, however, intervention is withdrawn, rate of return will go up causing a shift in demand for investment schedule to D1D1, which will be down ward sloping through out. This would result in higher investment and consequently income which would shift supply schedule of capital to S1S1. The investment would further increase to K* and rate of return would improve to r*. Rate of return improves because removal of intervention rations out low yielding investments. As the cost of capital goes up, the entrepreneurs are likely to switch to less capital-intensive technologies. Such technologies may not only raise the average productivity of capital, but also represent appropriate technology provided by relative availability and cost of labour and capital in the economy. Letting rate of return be determined by the market mechanism would reduce or even eliminate the costs involved in credit rationing arrangements and thereby enhance the efficiency of the economy as a whole. High rate of return would stimulate demand for financial assets and expand financial sector.

One of the bitter fruits of intervention has been the shrinkage of the securities market. When subject to effective expropriation through suppressed return on investment, people naturally seek a proper reward elsewhere, either through capital flight, through a retreat to underground or through the hoarding of goods. People keep their savings out of the markets. The underground sector allocates the resources, but relatively inefficiently. Another major consequence has been insulation of developing countries from international capital markets. The domestic market is shielded from competition. Misallocation of resources can result because of distorting interventions or the presence of market failure either in the goods market or in the securities market, which are interlinked. Improvement in allocation efficiency, therefore, requires removal of distortions from both the markets.

Three main sets of entities depend on securities market. While the corporates and governments raise resources from the securities market to meet their obligations, the households invest their savings in the securities. I will now dish out a few statistics, mostly taken from the Indian Securities Market Review, a publication of the National Stock Exchange, to indicate the level of significance. While corporate sector and governments together raised a total of Rs. 226,911 crore from the securities market during 2001-02, there are about 20 million investors who have invested in the securities. Tables 1 and 2 indicate the significance of the securities market in Indian economy.

[Source: Economic Intelligence service-Corporate Sector, CMIE, & RBI (copied from Indian Securities Market Review, Publication of NSEIL]

The Indian economy witnessed a descent growth of 6% per year in 1990s against euphemistically described as Hindu Growth Rate of 3.5% over preceding four decades. This was possible by contributions mostly by the organised secondary and tertiary sectors (industry and service). The securities market helped these organized sectors, corporate and government, to raise resources to realise a growth rate of 6%. Of late the activity in the securities market has slowed down, so also the level of activity in the economy.