What is the importance of financial markets in an economy?

Financial markets match buyers and sellers or lenders to buyers at a given

time and reflect the performance of the economy. Demand and supply are a
function of the market. Businesses need capital to grow and to expand their
respective business thus, where the financial market plays a critical role in the
buildup of capital and the production of goods and services providing access
to capital. In a well-developed and efficient market, the transaction costs are
always lower with efficient transfer of funds; it can be mean also a lower cost
of financing and a safe return on investment. In developing countries, which
have limited financial market, the poor legal system, transparency may make
it more costly to raise capital and may lower the return on savings or
investments Vis a Vis the risk. A good financial market helps in the
creation of wealth and provides a link between savings and investment
that meet the short-term and long-term financial needs of both the
household and corporate sector through efficient mobilization and
allocation of surplus.

Macroeconomic factors mentioned such as growth, inflation, business cycles,

etc have a strong impact on the financial markets. Financial structures fund
businesses and companies, contributing to job growth and, in turn, growing
economic development and trade. Increased trade leads to increased
competition, such as sales and marketing that increase jobs in these sectors
further. Whether it is primary, secondary and tertiary sectors all need
capital for growth, and the need for capital is balanced by the financial
system.

Security is a right on the issuer’s future income/profits or

assets. Usually, financial markets are characterized by transparent pricing,
simple trading rules, costs and fees, and market forces that decide the prices
of securities that sell.

Financial markets affect the opinion of the public and provide an outline of the
economic landscape. A continuous rise in stock exchanges such as
Nifty/BSE gives confidence to the businesses. In such scenarios,
businesses hire more employees, decreasing unemployment and in turn
producing more disposable income to the common people. In the case of the
diminishing market, or in the event of market crashes, business becomes
worried about their financing, making layoffs, and panic in the economic
ecosystem.

Capital markets and institutions such as banks play a key role in the economy
by controlling risks and allocating savings to productive activities, facilitating
economic development, and enhancing overall welfare while running
smoothly. The right mixture of the well-developed financial market and the
variety of capital products and resources available better fits the requirements
of investors, as well as those who are seeking capital and who has, have
excess capital. Thus fueling the engine of the economy or simply capital
formation. A sound economy can exist only when there is a well-
developed market.
The Indian financial market has developed and is bigger now after
liberalizing policies in 1991 and is different from what it used to be back
in the 1980s.

An efficient financial market can serve the following purposes:

 Supporting investors managing their capital for different time horizons

with financial products.
 It provides a source of capital for businesses depending on short-term
or long-term financing requirements for both private as well as the
government.
 Minimizing risks by some strategies such as hedging or diversification.
  Act as a mirror reflecting the economic conditions of the
country/states.

Confidence booster for attracting capital through foreign inflows or

investments.

Provides access to information to market participants enabling taking

precautionary measures.

The financial market has become a source of judging point on how global or
national economies are performing in today’s scenario. The effect of
government economic policies such as fiscal, monetary can be easily
observed on stock and bond exchange markets. The volume of trades in
stocks and bonds reflects the performance of the businesses as well as the
sovereign. For example, when RBI takes the decision to
increase/decrease interest rate, the effect can be easily observed on the
bond/equity market.

Financial markets are used by developed economies to maintain their

economic and social stability and increase their economic level. Dormant or
developing economies look at financial markets to finance its BOP (balance
of payments) accelerating its development agenda for social and economic
stability. For new economies or developing economies the growth of the
financial market depends on the reforms taken by the government, also
reforms should be in such a way that it should match the frequency of local or
international level investor's requirements. Thus, they give considerable
importance to the growth and development of the financial sector to achieve
their agent of employment generation and poverty reduction.

SOURCES: https://www.kundankishore.in/blog/what-is-the-importance-of-
financial-markets-in-an-economy