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A critical review of stock market development in India

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ACADEMIC PAPER

A critical review of stock market development in India

Samer Salameh | Asad Ahmad

Department of Management, Jamia Hamdard,

New Delhi, India
Correspondence
Asad Ahmad, Department of Management,
Jamia Hamdard, New Delhi, India.
Email: asad7babar@gmail.com
The development of stock markets in the financial sector has been important. The
expansion of stock markets has compelled various researchers to analyze its relation-
ship with the economic process and development of countries. The studies have rev-
ealed that the performance of stock markets in a nation has a positive correlation to
its economic growth. Bearing this relationship in mind, studies are being undertaken
to recognize the elements responsible for stock market development in several
nations. The researchers all around the world are trying to better understand deter-
minants so that government establishments can create and target policies that may
help the development of stock markets which further helps in economic development
of the state. Throughout the past three decades, the global stock markets surged,
and emerging markets played a vital role in this boom. Recent researches have begun
to concentrate on the linkages between the stock markets and economic develop-
ment. There has been an extensive analysis of the connection between the stock
market and economic growth, but there is a dearth of theoretical empirical proof on
what determines stock exchange development. Keeping in view the importance of
stock markets in the development of economic development, the researchers in the
present study have tried to bring out the factors that play a positive role in the devel-
opment of stock market.

1 | I N T RO DU CT I O N forms an integral part of the economies of nations. It helps in effi-

There is no concise definition for the phrase “stock market develop-
ment”, which has been frequently used in connotation with the stock
market. It is a complex term, which can be defined in terms of its size,
volatility, level of global integration and liquidity (Ho, 2017). However,
it has been widely analyzed in terms of the stock market size and
stock market liquidity (El-Wassal, 2013). To simplify things, the
researchers have defined stock market development by analyzing the
market capitalization ratio (MCR) which is also known as the Buffet
Indicator. It is also defined as “the total value of all publicly listed
shares in a country's stock market as a proportion of its Gross Domes-
tic Product (GDP)” (Adam & Tweneboah, 2008; Ben Naceur,
Ghazouani, & Omran, 2007; Ho, 2017; Ho & Odhiambo, 2019). It is a
good proxy for stock market development as it positively related to
mobilizing capital and diversifying risk.
It has been suggested by Pilinkus (2010) that stock markets facili-
tate the redistribution of financial resources among separate eco-
nomic entities like individuals, corporations, and governments, thus,
ciently allocating financial resources in an economy by raising capital
for business corporations and to further enabling the transfer of capi-
tal from one party to another, and mobilizing savings. The economic
growth of a nation heavily depends on the stock market and their role
in the recent past has been dominant. Keeping in mind the importance
of stock market, researchers have tried to analyze the role of stock
markets in the economic performance of countries (Greenwood &
Smith, 1997; Levine, 1991; Obstfeld, 1994). It has been found that
there is a positive correlation between the performance of stock mar-
ket and the economy of a nation. The same, Dagar (2014) explained
the important role of the stock market in achieving the wealth and
growth of an economy. By helping to direct the flow of savings and
investment in the economy in channels that support the stockpiling of
capital, shows a strong positive relationship between the stock market
and economic growth. The economic growth has an inverse relation
with the stock market prices, that is, the falling stock prices depict
economic depression whereas rising stock prices depict economic
growth (Pilinkus, 2009). In the light of the report issued by the World

J Public Affairs. 2020;e2316. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1 of 7
https://doi.org/10.1002/pa.2316
2 of 7
Federation of Exchanges (WFE) and the United Nations Conference
on Trade and Development (UNCTAD) (2017), which examines the
role of stock exchanges in promoting economic growth and sustain-
able development. There is a positive role of stock markets in eco-
nomic development. There has been an increase in the role of stock
markets in the financial sector which facilitates as a driver of eco-
nomic growth of a nation. This is shown by increasing share of per-
centage of stock market in global GDP (Figure 1).
The present study focuses on India as it is one of the largest
economies in the world and its financial sector have shown tremen-
dous growth with the implementation of economic reform 1991,
which has been booming since. Furthermore, it is at the forefront of
becoming one of the most influential countries in the global land-
scape. The results of several studies have shown that the performance
of the Indian stock market has a positive bearing on the country's eco-
nomic growth (Deena, 2013; Sindhu, 2013; Srinivasan & zation period is rare to be found.
Prakasam, 2014). Keeping in mind the backdrop of India's growing
stock market and its rising influence in the world, it is essential to
understand what drives the development of stock markets in India.
The Indian Stock Market has become increasingly popular both with
national and international investors. Furthermore, the share of per-
centage of stock market in India's GDP/GNI has been rising in the
recent years and has been significantly high when compared on a
global scale (Table 1). The researchers in the present study aim to bet-
ter understand the behavior of stock markets in India and represent
the decisions and policies in such a way that it proves advantageous
to all the stakeholders comprising investors, firms and governments.
The study also aims to suggest factors, which makes it suitable for the
stock markets to prosper in India.
1.1 | Research gap
Recent developments in the global fiscal markets in the past two
decades have encouraged many researchers to study the factors,
which affects the stock market development. The researchers in the
SALAMEH AND AHMAD
developed countries have given significant importance studying the
factors on economy as well as institution level. Despite the major
reforms done in the financial section and its' importance in the eco-
nomic growth of India, there are only few studies dealing the factors
as well as their impact on the stock market development. There is a
dearth of literature in the area of financial development in India
despite it being a promising research field. The same goes for concen-
trating on stock market development, which can be studied while con-
sidering several factors, especially the macroeconomic ones which is
very important. The focus on the relationship between financial devel-
opment and economic growth has been studied but it is found that
most of the studies have considered only one or two proxy variables
for financial development. There are some researches which are
related to the financial development and economic growth but a thor-
ough review of the financial development in the pre and post liberali-
2 | LI T E RA T U R E RE V I E W
There has been a significant amount of empirical evidence related to
the relationship between financial development and economic growth
by several researchers. However, there is a lack of empirical studies
dealing the relationship between macroeconomic variables and stock
market development for the emerging market economies like India. It
is considered a relevant area of research because of the increasing
importance of the growth of these markets in the economic develop-
ment process of a nation.
2.1 | Financial development and economic growth
Several researchers have tried to study and examine the relationship
between financial development and economic growth of a nation.
The systematic analysis of the connection between financial devel-
opment and economic development was first popularized by
F I G U R E 1 Stock Market
Capitalization to GDP for World.
Reprinted from Stock Market
Capitalization to GDP for World. (2017),
retrieved from https://fred.stlouisfed.org/
series/DDDM011WA156NWDB
SALAMEH AND AHMAD 3 of 7

TABLE 1 Total domestic market cap to GNI ratio of various countries

December 31, December 31, December 31, December 31, December 31, December 31, December 31,
Nation 2017 (%) 2016 (%) 2015 (%) 2014 (%) 2013 (%) 2012 (%) 2011 (%)
US 160.45 144.20 136.22 147.82 140.63 112.49 98.97
Canada 141.46 133.97 111.77 124.77 120.34 113.93 112.05
India 178.83 140.47 141.33 156.92 124.30 138.63 120.85
Japan 121.98 104.54 115.41 103.42 95.93 61.37 52.65
South 108.67 92.12 90.93 89.07 90.50 90.74 85.60
Korea
China 88.85 89.55 95.94 77.71 59.28 62.07 61.40
Germany 56.13 51.00 51.92 48.17 48.75 39.97 32.92
Italy 36.40 31.17 35.31 29.00 27.87 22.68 20.35
UK 122.65 115.42 114.51 117.47 126.14 110.95 113.91
Russia 41.67 45.18 39.99 33.64 39.78 41.97 47.19

Source: Reprinted from Market capitalization of listed domestic companies (% of GDP), retrieved from https://data.worldbank.org/indicator/CM.MKT.
LCAP.GD.ZS?view=chart. Copyright 2018 by the World Bank Group.

(Goldsmith, 1955). He found a sound correlation between financial
development and the level of real per capita (GDP). In their study,
Gregorio and Guidotti (1995) examined 95 countries to explore the
relation between financial development and the long-term growth of
the country. They classified the countries as high income, middle
income, and low-income countries. The variables employed in the
study were the magnitude relation of domestic credit to the non-
public sector to the gross domestic product, primary and secondary
ingress magnitude relation, gross domestic product per capita, gov-
ernment defrayment, investment rate. The findings of the study
suggested that there is an improvement in the growth performance
with additional financial development although the growth differed
from country to country. In another study, Xu (2000) investigated
41 countries to classify the effect of permanent financial develop-
ment on domestic investment. The data was collected for a range of
33 years (1960–1993) comprising variables such as real GDP, real
domestic investment and index of financial development. The study
results fortified the importance of financial development in the eco-
nomic growth of the countries.
The financial development of a country influences the growth of
the economy through three channels: first, it increases the marginal
productivity of capital; second, it raises the proportion of savings
channeled to investment and; third, it raises the non-public saving rate
(Aziz & Duenwald, 2002).
In a study by Minja (2012), the nature of the relationship between
financial development and economic growth in India and the direction
of the relationship between financial development and economic
growth has been analyzed. The results of the study showed that there
is a direct relation between financial development and economic
growth. While checking the causality between financial development
and economic growth it shows unidirectional causality. An interesting
finding of the study suggested that the pre-liberalization period finan-
cial development led to economic growth while in the post-
liberalization period economic growth leads to financial development.
2.2 | The Indian stock market, its development and
economic growth
The Bombay Stock Exchange (BSE) formed in 1875 and the National
Stock Exchange (NSE) founded in 1992 are the two stock exchanges
in India where most of the trading takes place. Sensex and Nifty are
the two prominent market indexes in India. Sensex provides time-
series data of 30 firms listed on the BSE representing 45% of the
index's total market capitalization. Whereas, Nifty provides time-
series data of 50 firms listed on the NSE representing 62% of the
index's total market capitalization (Singh, 2018). The Bombay Stock
Exchange is the oldest stock exchange in the whole of Asia and con-
tinues to remain as one of the major and most-recognized stock
exchanges in the world along-side NYSE, LSE, NASDAQ and Tokyo
Stock Exchange (Mukherjee, 2007).
Even though the BSE has been in existence since 1875, stock
markets in India started developing after the financial sector reforms
took place in 1991. Stock markets in India showed tremendous
growth in terms of market capitalization, market turnover and alloca-
tion efficiency of investments post liberalization of the economy
(Acharya, Amanulla, & Joy, 2009). According to the World Bank indi-
cators (2018), India was ranked sixth in terms of market capitalization
and 14th in terms of turnover ratio.
In the backdrop of such an expansion of the stock markets in
India, various studies were conducted to analyse the relationship
between the development of the stock market and economic growth
in India. It was found that the size of the stock market has a positive
association with economic growth (Biswal & Kamiah, 2000). In a
study, Chakraborty (2008) found that there is a causal link between
the growth rate of real GDP to stock market capitalization in the con-
text of India. Several researchers have established a prominent role of
the stock market development in the economic growth process of
India (Agrawalla & Tuteja, 2007; Deb & Mukherjee, 2008;
Padhan, 2007; Paramati & Gupta, 2011). Given the growing role of
4 of 7
the stock market in India and its impressive global influence, it is
worthwhile to analyse the factors driving the development behind the
stock market in India.
2.3 | Determinants of stock market development
The Traditional growth literature emphasized the role of fiscal policy
in economic growth (Mckinnon, 1973; Solow, 1956), but it did not
include the stock market and the financial intermediation as other
factors involved in the growth of the economy. In their study, Garcia
and Liu (1999) examined the macroeconomic determinants of stock
market development, particularly market capitalization in 15 indus-
trial and developing countries. The results of their study suggested
real income; saving rate, financial intermediary development, and
stock market liquidity as important determinants of stock market
capitalization. Macroeconomic factors such as income level, gross
domestic investment, banking sector development, private capital
flows, and stock market liquidity are important determinants of stock
market development in emerging market countries (Yartey, 2010).
The results have also shown that political risk, law, order, and
bureaucratic quality helps in enhancing the viability of external
finance thus these factors also serve as important determinants of
stock market development. In a study of 10 developing Asian
nations, it was found that the stock market and the tax revenue
influences economic growth. The study results also indicate that for
market economic progress, governments of the developing nations
ought to improve the channels between the securities market, taxa-
tion policy, and economic process by developing securities market
liquidity and by characteristic growth-oriented tax reform methods
(Colombage, Maslyuk, & Taha, 2015). In another study the results
showed FDI, savings, economic process, trade openness, exchange
rates, banking sector development, and exchange liquidity, as the
factors which had a positive impact on the exchange development in
emerging markets (Tsaurai, 2018).
Numerous studies have established the importance of stock mar-
ket in accelerating the economic growth of nations as provided in the
former section of the paper. Given this background, studies have been
conducted to identify the determinants of stock market development
and they have been classified under three broad categories—
microeconomic factors, macroeconomic factors and institutional fac-
tors (Ho, 2017; Ho & Odhiambo, 2019).
2.4 | Microeconomic factors
Microeconomic factors that are responsible for the development of
stock markets are mainly asset-pricing theories. These theories evalu-
ate the essential value of a stock, which in turn determines its price,
which is consequently important to the development of stock markets
(Ho, 2017). There exists an extensive body of literature that has linked
the development of stock markets with asset-pricing models such as
SALAMEH AND AHMAD
the capital asset pricing model and arbitrage pricing theory. The
microeconomic factors can be further broken into two components.
One consists of market or systematic risk that cannot be diversified
away such as inflation, economic growth, interest rate, foreign
exchange rate, tax rate and other such variables (Ho, 2017; Ho &
Odhiambo, 2019; Merton, 1973; Sharpe, 1964). The other component
consists of portfolio or unsystematic risk that can be diversified away
by choosing efficient portfolios that maximise the return for a given
level of risk (Ho, 2017; Ho & Odhiambo, 2019; Fama, 1965;
Ross, 1976).
2.5 | Macroeconomic factors
The main macroeconomic factors determining the development of
stock markets have been suggested to be economic growth, FDI and
role of foreign institutional investors (FIIs), stock market liquidity,
inflation rate, trade openness, and banking sector development
(Bayar, 2016; Ben Naceur et al., 2007; El-Wassal, 2005; Garcia &
Liu, 1999; Law & Habibullah, 2009). The economic growth of a nation
is suggested to have a positive role in the development of its stock
market. It has been proposed that the economic development reduces
the per-capita fixed costs associated with the stock market which fur-
ther results in an increase in the number of market participants; which
further leads into the development of the stock market (Atje &
Jovanovic, 1993; Garcia & Liu, 1999; Greenwood & Smith, 1997;
Ho, 2017; Samal, 1997). Study conducted by Dhiman (2013) has
shown that there exists a strong positive correlation between FDI and
the stock markets in India. In a research based on CNX Nifty and
BSE Sensex during the period 2006–2016 it was found that FDI
had a positive impact in moving both the CNX Nifty and BSE Sen-
sex (Gupta, 2017). The results of the study indicated that there
was an increase in the market capitalization of BSE Sensex and
CNX Nifty with the elevation in the FDI inflow (Table 2). FIIs have
been discovered to have no effect on the stock market develop-
ment in India although they affect the stock prices and stock mar-
ket volatility quite significantly (Samal, 1997). Stock market
liquidity has a positive impact on stock market development. The
degree of liquidity is higher with the high value traded ratio
(VT) and turnover ratio (TR) which further helps the market to be
more developed (Bencivenga, Smith, & Starr, 1996; Biswas, 2006;
Levine, 1991). Trade openness also plays a significant role in
developing the stock market in developing and low-income coun-
tries such as Bangladesh, Ghana, India and Pakistan (Baltagi,
Demetriades, & Law, 2009). There is ample existing literature
review to determine the effect of banking sector development of
the stock market development of a nation. Since the aim of both
the banking sector and stock market is the same in terms of
mobilising savings and efficiently allocating investment funds,
they may be either complements or substitutes (Ben Naceur
et al., 2007; Boyd & Smith, 1996; Demirgüç-Kunt & Levine, 1996;
Garcia & Liu, 1999).
SALAMEH AND AHMAD 5 of 7

TABLE 2 FDI as a determinant of stock market development in 3 | CONCLU SION AND D ISCU SSIO N
India

Year FDI (US $ MILLION) BSE sensex CNX nifty The aim of the study was to identify the determinants of stock market

2006–2007 22,826 12,277.33 3,572.44 development in India by reviewing the literature in this area. The pre-
sent review has tried to contribute by exploring the efforts of
2007–2008 34,835 16,568.89 4,896.59
researchers in defining the process of stock market development
2008–2009 41,874 12,365.55 3,731.02
based on many indicators such as size, volatility, and market capitali-
2009–2010 37,745 15,585.21 4,657.76
zation. It is important to implement a standardized way of defining
2010–2011 34,847 18,605.18 5,583.54
stock market developments. Several researchers have tried to explain
2011–2012 46,556 17,422.88 5,245.10
stock market development in terms of market capitalization ratio but
2012–2013 34,289 18,202.10 5,520.34
it is an ambiguous term and open to interpretations. Market capitaliza-
2013–2014 36,046 20,120.12 6,009.51 tion ratio alone cannot define stock market development. The grow-
2014–2015 45,148 26,556.53 7,962.17 ing importance of stock markets in the financial world, numerous
2015–2016 55,457 26,322.10 7,981.35 research studies have been carried out to prove the positive relation

Source: Reprinted from An Analysis of Impact of FDI on Indian Stock Mar-
ket: with Special Reference to BSE-SENSEX and NSE-CNX NIFTY, by
Honey Gupta, retrieved from: https://www.researchgate.net/publication/
326711510_An_Analysis_of_Impact_of_FDI_on_Indian_Stock_Market_
with_special_reference_to_BSE-SENSEX_and_NSE-CNX_NIFTY.
2.6 | Institutional factors
Research studies conducted on the effect of institutional factors on
the development of stock markets has been contradictory. On one
hand, Pagano (1993) has shown in his study that regulatory and
institutional factors such as tax laws, supervision by regulatory
authority, and liberalization play a prominent role in the functioning
of stock markets. On the other hand, study by Demirgüç-Kunt and
Levine (1996) found out that the effect of variables like regulatory
framework can be seen in the macroeconomic determinants. For
instance, legal rule is discovered to have a high positive correlation
with liquidity of stock markets but stock market liquidity itself is
one of the macroeconomic factors behind stock market develop-
ment. In the context of India, study findings have suggested that
the regulatory framework of stock markets in India plays a signifi-
cant role in its development (Joshi, 2013). The factors like capital,
trade and investment liberalization (result of financial sector
reforms of 1991) and the creation of SEBI, the regulatory body of
Indian stock markets, has been found to have a huge impact in
developing the stock markets in India (Biswal & Kamaiah, 2001;
Srinivasan & Prakasam, 2014). Companies with higher liquidity are
considered to be companies with better corporate governance
(Prasanna & Menon, 2012). In their study Prasanna and Menon
(2012) focused on finding out the role of corporate governance on
the stock liquidity. They found a positive relationship between the
two variables. To find out the key factors which support the growth
of the stock market Das and Swain (2019) analyzed the panel data
from 2003 to 2016. Based on international country risk guide
(ICRG), political risk was used as a variable related to the institu-
tional part. Interestingly it was found that the political risk plays an
insignificant role in the stock market growth.
between stock market development and economic advancement of a
nation. With the growing importance of stock markets in the eco-
nomic development, researchers throughout the world have been
attracted to carry out their research works in this area. It has got a
prime spot in the researchers of developing economies with the liber-
alization of their stock markets.
In this context, the researchers in the present study have tried to
take a closer look of the stock market development of India. As it is
one of the largest economies in the world, and the financial sector has
witnessed many developments post liberalization. Despite the signifi-
cant expansion and development of the financial sector in India, espe-
cially in the stock market, there is a dearth in the number and kind of
research and studies, which deals with the development and outlook
of this sector. The rationale behind this study was to, therefore,
understand and determine the drivers of stock market development in
India and highlight the existing literature gap in the field. The
researchers have tried to bring out several factors both in the devel-
oped as well as developing nations and the impact of those variables
on stock market development. The variables determining the stock
market development of a nation can be classified under three
categories—microeconomic, macroeconomic and institutional factors.
There has been an extensive research on the microeconomic fac-
tors thus, the researchers in the present study was primarily inter-
ested in finding macroeconomic and institutional factors determining
the stock market development. The key macroeconomic determinants
could be the economic growth, foreign investment, stock market
liquidity, inflation, degree of trade openness and banking sector devel-
opment. These variables has been suggested to have a positive impact
on stock market development except for inflation, which is supposed
to have a negative relationship with stock market development. Insti-
tutional factors have had a significant influence on the development
of stock markets all around the globe. Stock and Exchange Board of
India have changed the total scenario of the Indian Stock market. It
has played a prominent role in developing the stock market in the
country.
Researches may focus on the factors that determine the
growth of the Indian stock market and its importance. The impact
of liberalization policy in the financial sector on economic growth
6 of 7
and stock market development may also be an interesting study.
Most of the earlier studies have relied on only one or two variables
to study the financial and economic development. It is also impor-
tant to come up with several other researches which study a wide
range of proxy variables that may also have a significant role in
financial development. By reviewing several researches that
focused on the factors that affect Indian stock market, the
researchers have found only a limited number of studies, which
focus only on limited factors. Another issue that can be brought up
after reviewing the extant literature is that, there are certain con-
tradictions in the results with respect to the factors like inflation,
oil prices and political situation. Thus, researchers could come up
with a study considering these factors with a sound and clear
methodology. Conducting more studies to recognize the elements
responsible for stock market development in several nations will
help and form the basis for better understanding the factors. Thus,
can be helpful for the policymakers in creating and targeting poli-
cies that are beneficial towards the development of nation through
the proper prosper of stock markets.
ORCID
Asad Ahmad https://orcid.org/0000-0003-3078-0979
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Pilinkus, D. (2010). Macroeconomic indicators and their impact on stock
market performance in the short and long run: the case of the Baltic
Samer Salameh is a Research Scholar in the Department of Man-
States. Technological and Economic Development of Economy, 16(2),
291–304. agement, School of Management and Business Studies, Jamia
Prasanna, P. K., & Menon, A. S. (2012). Corporate governance and stock Hamdard, New Delhi, India. He holds a Master's degree in Finan-
market liquidity in India. International Journal of Behavioural Accounting cial and Monetary Economics from Damascus University, Damas-
and Finance, 3(1-2), 24–45.
cus, Syria. His research interest includes international trade,
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economic relations among countries, and post-war reconstruction
Economic Theory, 13(3), 341–360.
Samal, K. C. (1997). Emerging equity market in India: Role of foreign insti- of an economy.
tutional investors. Economic and Political Weekly, 32(42), 2729–2732.
Retrieved from. http://www.jstor.org/stable/4405983 Asad Ahmad is an Assistant Professor in the Department of Man-
Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium agement, Jamia Hamdard, New Delhi, India. He holds a PhD in
under conditions of risk. The Journal of Finance, 19(3), 425–442. Marketing from Aligarh Muslim University, India. His research and
Sindhu, K. (2013). Stock market behavior and economic growth in India
publication revolves around behavioural patterns of the online
(Doctoral thesis, The Mahatma Gandhi University, Kottayam, India).
Retrieved from https://sg.inflibnet.ac.in/handle/10603/7105.
buyers. He has published research papers in journals like Journal
Singh, R. (2018). BSE Sensex: Case study of political events as a major fac- of Research in Interactive Marketing, Young Consumers, Journal of
tor which impacts Sensex. International Journal of Research in Finance Internet Commerce, Interactive Technology and Smart Education.
and Management, 1(1), 9–12.
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The Quarterly Journal of Economics, 70(1), 65–94.
Srinivasan, P., & Prakasam, K. (2014). Stock Market Development and Eco-
nomic Growth in India: An Empirical Analysis. Munich Personal RePEc How to cite this article: Salameh S, Ahmad A. A critical review
Archive, 1. of stock market development in India. J Public Affairs. 2020;
Tsaurai, K. (2018). What are the determinants of stock market develop-
e2316. https://doi.org/10.1002/pa.2316
ment in emerging markets. Academy of Accounting & Financial Studies
Journal, 22(2), 1–11.

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