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State of the Indian Securities Market: Evidence from the Flow of Funds Accounts of the Indian
Economy — Venkateswaran R.*

“As for securities and the stock market, are they finally good or bad? Are they dangerous? Are they
things that only capitalism has or can socialism also make use of them? To decide whether they can be used, we
must experiment first. If we think they work, if after a year or two we think they are good, then we can expand
them. If problems arise, we can close them down, immediately and completely. And even if we close them
down, we can do so quickly or slowly, or we could even leave a little tail.”
-- Deng Xiaoping (1992)

I. Introduction
India’s financial markets have evolved and undergone structural change during the course of the eco-
nomic reforms. The Indian economy shifted to higher growth trajectories during the same period. The Indian se-
curities market proved the harbinger of the modern Indian financial markets. The rapid strides made (of course,
some dictated by time and circumstances) have helped the Indian securities market emerge as a benchmark for
the rest of the world.

The Securities and Exchange Board of India (SEBI) was initially constituted as a non-statutory body on
April 12, 1988 through an Extraordinary Notification of the Government of India for dealing with all matters re-
lating to development and regulation of securities market and investor protection and to advise the Govern-
ment on all these matters. An Ordinance promulgated by His Excellency the President of India on January 30,
1992 conferred statutory status and powers on SEBI. SEBI was set up as a statutory body on February 21, 1992.
The Ordinance was replaced by an Act of the Parliament on April 04, 1992. The preamble to the SEBI Act, 1992
(Act No. 15 of 1992) states that SEBI has been established to protect the interests of investors in securities and
to promote the development of, and to regulate, the securities market and for matters connected therewith or
incidental thereto.

This Article seeks to trace the development of the Indian securities market during the period 1990 –
2008, as is evident from the flow of funds accounts. It is organized as follows. Section II traces the theoretical
foundation of the flow of funds accounts, while the various financial development ratios have been defined in
Section III. Section IV introduces the flow of funds accounts of the Indian economy. The trends in India’s financial
development ratios are presented in Section V. Section VI concludes.

*Shri Venkateswaran R. is Assistant Director, Securities and Exchange Board of India (SEBI). The views expressed are strictly personal and
do not necessarily reflect those of the employer. Comments, if any, may be mailed to [email protected]

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II. Literature Review

The extant literature describes the modern flow of funds accounts as representing a systematic record of net
transactions involving financial instruments during a given period of time. The flow of funds accounts are a branch of
social accounting of a country. J.R. Hicks had pointed out the inadequacy of national income and expenditure ac-
counts to judge the performance of an economy and introduced the concept of national balance sheets. The modern
flow of funds accounts are based on M A Copeland’s pioneering work titled “A Study of Moneyflows in the United
States” (1952). A well established statistical framework for presenting the flow of funds accounts is provided by the
United Nations System of National Accounts.

III. An Introduction to the Flow of Funds Accounts

All the economic transactions in a monetized economy involve the exchange of financial claims among the
participants. The flow of funds accounts serve as a useful analytical tool in many respects: identification of individual
sectors having financial surpluses or deficits, determination of the causes of these surpluses/deficits, the financing of
the deficits and, thereby, the inter-sectoral linkages, tracing the growth of important economic institutions, such as
the mutual funds, identification of the pattern of financing of the capital stocks, assessment of the impact of mone-
tary policy actions, to name a few. In this Article, we restrict ourselves to profiling the Indian securities market, as
seen through the financial development ratios derived from the flow of funds accounts of the Indian economy.

Financial claims issued by the economic agents are classified as primary issues and secondary issues. Primary
issues are the claims issued by non-financial sector or the ultimate borrowers. Claims issued by the financial interme-
diaries, on the other hand, are called secondary issues. The flow of funds accounts provide data on financial claims
which can be further analysed to assess the depth and maturity of the financial markets.

The finance ratio is the ratio of total financial claims (or total financial issues) to national income. This is an
indicator of the rate of financial development in relation to economic growth. The financial interrelations ratio is the
ratio of total financial issues to net domestic capital formation. This measure reflects the relation between financial
development and the growth of physical investment.

The new issue ratio is the ratio of primary issues to net domestic capital formation. This ratio is indicative of
the extent of dependence of the non-financial sector on its own funds in financing the capital formation. The inter-
mediation ratio is the ratio between the financial instruments issued by the financial institutions (i.e., secondary is-
sues) and the financial instruments issued by the non-financial sector (i.e., primary issues). This ratio reflects the im-
portance of intermediation by banks and other financial institutions in financing real activities.

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IV. Flow of Funds Accounts of the Indian Economy

According to the Reserve Bank of India (RBI), flow of funds accounts is a set of accounts which depicts
the inter-sectoral flow of funds among major sectors of the economy ‘from whom to whom’ basis. The RBI has
been publishing the flow of funds accounts of the country since December 1964. The data for India, at present,
pertain to one year, the financial year. The published accounts pertaining to the period 1951–52 to 2007–08 are
available in the several issues of the RBI’s monthly Bulletin.

In the Indian economy, the institutional units, i.e., the economic entities capable of engaging in transac-
tions with other units, are grouped into six categories, viz., (i) banking sector; (ii) other financial institutions;
(iii) private corporate business; (iv) government sector; (v) rest of the world; and (vi) household sector. Financial
assets and liabilities are classified under ten major categories of financial instruments, viz., (i) currency; (ii) de-
posits; (iii) investments; (iv) loans and advances; (v) small savings; (vi) life funds; (vii) provident funds; (viii)
trade debts; (ix) foreign claims not elsewhere classified; and (x) other claims not elsewhere classified.

This Article seeks to trace the development of the Indian securities market during the 1990 – 2008, as is
evident from the flow of funds accounts. Wherever the reporting period has overlapped, we have taken into ac-
count the latest data. The data on the indicators of India’s financial development have been presented in Table I
and Chart I.

V. India’s Financial Development Ratios: 1990 – 91 to 2007 – 08

Over the period, in consonance with the development of the financial markets, total financial issues rose
phenomenally. While the total financial issues were only Rs. 1,67,524 crore in 1990 – 91 and Rs. 7,79,226 crore in
2000 – 01, the total financial issues amounted to Rs. 29,17,987 crore in 2007 – 08. During the decade 1997 – 98 to
2007 – 08, the total financial issues registered a CAGR of 17.08%. The secondary issues and primary issues regis-
tered comparable CAGRs of 18.24% and 16.25% respectively during the same period. Similarly, during the five
years between 2002 – 03 and 2007 – 08, total financial issues registered a CAGR of 23.61%. The secondary issues
and primary issues registered CAGRs of 25.55% and 22.20% respectively during the same period.

The finance ratio exhibited an increasing trend during this period and stood at 0.77 during 2007 - 08. This
once again reaffirms the fact that the growth in the total financial issues have at least kept pace with the eco-
nomic growth during the period.

The financial interrelations ratio exhibited year-to-year fluctuations during the period. The emergence
of kinks in the financial interrelations ratio is attributed to the acceleration/deceleration in the investment ac-
tivity or the net domestic capital formation. The financial interrelations ratio rose from 1.72 during 2004 – 05 to
2.18 during 2007 – 08. It may be inferred that there is a higher level of participation of the financial system in
the domestic capital formation process.
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The new issue ratio ranged from 1.01 to 2.23 during the period. The sharp fluctuations in the new issue ratio
are also attributed to the acceleration/deceleration in the investment activity or the net domestic capital formation.
During 2006 – 07 and 2007 – 08, the new issue ratio displayed an increasing trend. If this trend is sustained in the sub-
sequent years, we may infer a greater role of financial disintermediation in the domestic capital formation process.

The intermediation ratio remained between 0.46 and 0.90 during the period. The intermediation ratio remain-
ing below 1.00 points to the lower involvement of the financial sector in the secondary issues as compared to the pri-
mary issues.

The trends in all the financial development ratios, thus, reflect the gradualist approach in the economic re-
forms that India embraced. Looking at from the securities market angle, the growth in the volume of financial issues
would have definitely contributed to growth in market capitalization, growth in investor population, development of
financial institutions and market participants, lower weighted average cost of capital for the India Inc., more business
and increased revenues and profits for the market intermediaries, product innovation, greater stock market liquidity
and lower market impact costs.

Conclusions

It is evident that despite the short term oscillations, various financial development ratios have been on an
upward trajectory over the medium term and the long term. The developments in the financial sector have a signifi-
cant bearing on the real sector. The experience during the current global financial crisis has underscored the same.
The financial development indicators have, thus, emphasized the need for carrying forward the comprehensive re-
forms in the economy, covering both the real and the financial sectors.

It is widely recognized that the development of the securities market brings in a host of benefits, including
the creation of more complete financial markets, facilitating financial disintermediation and risk diversification, fi-
nancing of the government deficit, smooth conduct of the monetary policy, sterilization of capital inflows and prod-
uct innovation. Further reforming the securities market in India will, thus, usher in greater benefits.

The High Level Committee on Savings and Investment (2009) (HLC) has identified the new challenges in com-
piling the flow of funds accounts in the context of the widening and deepening of the Indian financial system during
the last two decades. The recommendations of the HLC, once implemented, will remove the data gaps and broaden
the coverage of the flow of funds accounts. SEBI, among other institutions, has also been assigned a role to gather the
relevant information from the regulated entities for incorporation in the flow of funds accounts.

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Table I: Indicators of India's Financial Development

(Rs. crore)

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99

I. Secondary Issues 71,016 106,386 95,790 142,897 186,675 140,337 185,638 240,884 277,498
N E W S L E T T E R

II. Primary Issues 96,508 131,918 113,990 159,200 223,512 246,614 222,351 362,009 367,061

II.1 Domestic Sectors 103,558 124,666 117,511 140,079 208,448 239,849 193,502 342,359 350,075

II.2 Rest of the World -7,050 7,252 -3,521 19,121 15,064 6,765 28,849 19,650 16,986

III. Total Issues (I + II) 167,524 238,304 209,780 302,097 410,187 386,951 407,989 602,893 644,559

IV. Net Domestic Capital Formation 96,000 81,034 96,603 109,946 162,341 197,127 198,627 238,099 241,820

V. National Income 418,074 479,612 546,023 637,996 815,142 955,150 1,115,449 1,241,019 1,434,826
( c o n t d . . )

VI. Finance Ratio 0.40 0.50 0.38 0.47 0.51 0.41 0.37 0.49 0.46

VII. Financial Inter-relations Ratio 1.75 2.94 2.17 2.75 2.48 1.92 2.06 2.71 2.87

VIII. New Issue Ratio 1.01 1.63 1.18 1.45 1.35 1.22 1.12 1.63 1.63

IX. Intermediation Ratio 0.74 0.81 0.84 0.90 0.84 0.57 0.83 0.67 0.76

Source: Reserve Bank of India

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Table I: Indicators of India's Financial Development (Concluded)

(Rs. crore)

1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

I. Secondary Issues 273,759 294,765 302,636 412,295 441,713 495,885 678,092 812,299 1,286,082

II. Primary Issues 307,956 484,461 652,984 598,771 665,771 677,199 862,361 1,286,476 1,631,905

II.1 Domestic Sectors 293,354 434,573 590,853 535,123 524,011 552,807 760,250 1,056,715 1,252,510
N E W S L E T T E R

II.2 Rest of the World 14,602 49,888 62,131 63,648 141,760 124,392 102,111 229,761 379,395

III. Total Issues (I + II) 581,715 779,226 955,620 1,011,067 1,107,484 1,173,084 1,540,452 2,098,776 2,917,987
Net Domestic
IV. Capital Formation 320,651 303,677 292,359 367,528 479,277 682,171 892,318 1,084,768 1,336,064

V. National Income 1,585,502 1,696,387 1,849,361 1,994,217 2,237,414 2,526,285 2,875,958 3,312,569 3,787,596
( c o n t d . . )

VI. Finance Ratio 0.34 0.42 0.52 0.51 0.49 0.46 0.54 0.63 0.77

Financial Inter-
VII. relations Ratio 1.90 2.58 3.27 2.75 2.31 1.72 1.73 1.93 2.18

VIII. New Issue Ratio 1.01 1.60 2.23 1.63 1.39 0.99 0.97 1.19 1.22

Intermediation
IX. Ratio 0.89 0.61 0.46 0.69 0.66 0.73 0.79 0.63 0.79
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Source: Reserve Bank of India
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 Chart I: Financial Development Ratios: 1990 - 91 to 2007 - 08
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3.00

2.50

2.00
N E W S L E T T E R

Ratios
1.50

1.00
( c o n t d . . )

0.50

0.00

1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08

1999-2000

Year
Finance Ratio Financial Interrelations Ratio New Issue Ratio Intermediation Ratio
F eA bu rguuas rt y 22 00 11 01

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References

Jadhav, Narendra: Development of Securities Market – The Indian Experience

Levine, Ross (1997): Stock Markets, Economic Development and Capital Control Liberalisation (Investment Company
Institute Perspective)

Reserve Bank of India (1998): Flow of Funds Accounts of the Indian Economy: 1990 – 91 to 1993 – 94

--- (2000): Flow of Funds Accounts of the Indian Economy: 1951 – 52 to 1995 – 96
--- (2007): Flow of Funds Accounts of the Indian Economy: 1994 – 95 to 2000 – 01
--- (2009): Flow of Funds Accounts of the Indian Economy: 2001 – 02 to 2007 – 08

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