Mark Twain once divided the world into two kinds of people: those who have seen the

famous Indian monument, the Taj Mahal, and those who haven't. The same could be said
about investors.

There are two kinds of investors: those who know about the investment opportunities in India
and those who don't. India may look like a small dot to someone in the U.S., but upon closer
inspection, you will find the same things you would expect from any promising market.

Here we'll provide an overview of the Indian stock market and how interested investors can
gain exposure.

(For related reading, check out Fundamentals Of How India Makes Its Money.)

The BSE and NSE

Most of the trading in the Indian stock market takes place on its two stock exchanges:
the Bombay Stock Exchange (BSE) and the National Stock Exchange(NSE). The BSE has
been in existence since 1875. The NSE, on the other hand, was founded in 1992 and started
trading in 1994. However, both exchanges follow the same trading mechanism, trading hours,
settlement process, etc. At the last count, the BSE had more than 5,000 listed firms, whereas
the rival NSE had about 1,600. Out of all the listed firms on the BSE, only about 500 firms
constitute more than 90% of its market capitalization; the rest of the crowd consists of
highly illiquidshares.

Almost all the significant firms of India are listed on both the exchanges. NSE enjoys a
dominant share in spot trading, with about 70% of the market share, as of 2009, and almost a
complete monopoly in derivatives trading, with about a 98% share in this market, also as of
2009. Both exchanges compete for the order flow that leads to reduced costs, market
efficiency, and innovation. The presence of arbitrageurs keeps the prices on the two stock
exchanges within a very tight range.

(To learn more, see The Birth Of Stock Exchanges.)

Volume 75%
1:49

An Introduction To The Indian Stock Market

Trading Mechanism
Trading at both the exchanges takes place through an open electronic limit order book in
which order matching is done by the trading computer. There are no market
makers or specialists and the entire process is order-driven, which means that market
orders placed by investors are automatically matched with the best limit orders. As a result,
buyers and sellers remain anonymous. The advantage of an order-driven market is that it
brings more transparency by displaying all buy and sell orders in the trading system.
However, in the absence of market makers, there is no guarantee that orders will be executed.

All orders in the trading system need to be placed through brokers, many of which provide an
online trading facility to retail customers. Institutional investors can also take advantage of
the direct market access (DMA) option in which they use trading terminals provided by
brokers for placing orders directly into the stock market trading system.

Settlement and Trading Hours

Equity spot markets follow a T+2 rolling settlement. This means that any trade taking place
on Monday gets settled by Wednesday. All trading on stock exchanges takes place between
9:55 am and 3:30 pm, Indian Standard Time (+ 5.5 hours GMT), Monday through Friday.
Delivery of shares must be made in dematerialized form, and each exchange has its
own clearing house, which assumes all settlement risk by serving as a central counterparty.

Market Indexes
The two prominent Indian market indexes are Sensex and Nifty. Sensex is the oldest market
index for equities; it includes shares of 30 firms listed on the BSE, which represent about
45% of the index's free-float market capitalization. It was created in 1986 and provides time
series data from April 1979, onward.

Another index is the Standard and Poor's CNX Nifty; it includes 50 shares listed on the NSE,
which represent about 62% of its free-float market capitalization. It was created in 1996 and
provides time series data from July 1990, onward.

(To learn more about Indian stock exchanges, please go

to http://www.bseindia.com/ and http://www.nse-india.com/.)

Market Regulation
The overall responsibility of development, regulation, and supervision of the stock market
rests with the Securities and Exchange Board of India (SEBI), which was formed in 1992 as
an independent authority. Since then, SEBI has consistently tried to lay down market rules in
line with the best market practices. It enjoys vast powers of imposing penalties on market
participants, in case of a breach.

(For more insight, see http://www.sebi.gov.in/.)

Who Can Invest In India?

India started permitting outside investments only in the 1990s. Foreign investments are
classified into two categories: foreign direct investment (FDI) and foreign portfolio
investment (FPI). All investments in which an investor takes part in the day-to-day
management and operations of the company are treated as FDI, whereas investments in
shares without any control over management and operations are treated as FPI.

For making portfolio investment in India, one should be registered either as a foreign
institutional investor (FII) or as one of the sub-accounts of one of the registered FIIs. Both
registrations are granted by the market regulator, SEBI. Foreign institutional investors mainly
consist of mutual funds, pension funds, endowments, sovereign wealth funds, insurance
companies, banks, and asset management companies. At present, India does not allow foreign
individuals to invest directly in its stock market. However, high-net-worth individuals (those
with a net worth of at least US$50 million) can be registered as sub-accounts of an FII.
Foreign institutional investors and their sub-accounts can invest directly into any of the
stocks listed on any of the stock exchanges. Most portfolio investments consist of investment
in securities in the primary and secondary markets, including shares, debentures,
and warrants of companies listed or to be listed on a recognized stock exchange in India. FIIs
can also invest in unlisted securitiesoutside stock exchanges, subject to the approval of the
price by the Reserve Bank of India. Finally, they can invest in units of mutual funds and
derivatives traded on any stock exchange.

An FII registered as a debt-only FII can invest 100% of its investment into debt instruments.
Other FIIs must invest a minimum of 70% of their investments in equity. The balance of 30%
can be invested in debt. FIIs must use special non-resident rupee bank accounts, in order to
move money in and out of India. The balances held in such an account can be fully
repatriated.

Restrictions and Investment Ceilings

The government of India prescribes the FDI limit and different ceilings have been prescribed
for different sectors. Over a period of time, the government has been progressively increasing
the ceilings. FDI ceilings mostly fall in the range of 26-100%.

By default, the maximum limit for portfolio investment in a particular listed firm is decided
by the FDI limit prescribed for the sector to which the firm belongs. However, there are two
additional restrictions on portfolio investment. First, the aggregate limit of investment by all
FIIs, inclusive of their sub-accounts in any particular firm, has been fixed at 24% of the paid-
up capital. However, the same can be raised up to the sector cap, with the approval of the
company's boards and shareholders.

Secondly, investment by any single FII in any particular firm should not exceed 10% of the
paid-up capital of the company. Regulations permit a separate 10% ceiling on investment for
each of the sub-accounts of an FII, in any particular firm. However, in the case of foreign
corporations or individuals investing as a sub-account, the same ceiling is only 5%.
Regulations also impose limits for investment in equity-based derivatives trading on stock
exchanges.

(For current restrictions and investment ceilings go to https://rbi.org.in/)

Investments for Foreign Entities

Foreign entities and individuals can gain exposure to Indian stocks through institutional
investors. Many India-focused mutual funds are becoming popular among retail investors.
Investments could also be made through some of the offshore instruments, like participatory
notes (PNs) and depositary receipts, such as American depositary receipts (ADRs), global
depositary receipts (GDRs), and exchange-traded funds (ETFs) and exchange-traded
notes (ETNs).

As per Indian regulations, participatory notes representing underlying Indian stocks can be
issued offshore by FIIs, only to regulated entities. However, even small investors can invest
in American depositary receipts representing the underlying stocks of some of the well-
known Indian firms, listed on the New York Stock Exchange and Nasdaq. ADRs are
denominated in dollars and subject to the regulations of the U.S. Securities and Exchange
Commission (SEC). Likewise, global depositary receipts are listed on European stock
exchanges. However, many promising Indian firms are not yet using ADRs or GDRs to
access offshore investors.

Retail investors also have the option of investing in ETFs and ETNs, based on Indian stocks.
India ETFs mostly make investments in indexes made up of Indian stocks. Most of the stocks
included in the index are the ones already listed on NYSE and Nasdaq. As of 2009, the two
most prominent ETFs based on Indian stocks are the Wisdom-Tree India Earnings Fund
(EPI) and the PowerShares India Portfolio Fund (PIN). The most prominent ETN is the
MSCI India Index Exchange Traded Note (INP). Both ETFs and ETNs provide a good
investment opportunity for outside investors.

The Bottom Line

Emerging markets like India, are fast becoming engines for future growth. Currently, only a
very low percentage of the household savings of Indians are invested in the domestic stock
market, but with GDP growing at 7%-8% annually and a stable financial market, we might
see more money joining the race. Maybe it's the right time for outside investors to seriously
think about joining the India bandwagon.

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Related Terms

Standard and Poor's CNX Nifty Definition

Standard and Poor's CNX Nifty is a stock index composed of 50 of the
largest and most liquid stocks on the National Stock Exchange (NSE) of
India.
more
Making Money Abroad: How Foreign Portfolio Investment (FPI) Works
Foreign portfolio investment (FPI) is securities and other assets passively
held by foreign investors, allowing individuals to invest overseas.
more
Participatory Notes Allow Foreign Investors to Buy Indian Securities
Participatory notes are financial instruments required by investors or hedge
funds not registered with the Securities and Exchange Board of India to
invest in Indian securities.
more
Depositary Receipt: What Everyone Should Know
A depositary receipt (DR) is a negotiable financial instrument issued by a
bank to represent a foreign company's publicly traded securities.
more
Foreign Institutional Investor (FII)
Foreign institutional investors (FII) typically consist of large investment
companies that do business in countries other than where they are
located.
more
International Depository Receipt (IDR)
An international depository receipt or IDR is a negotiable certificate that
bank issues.
more