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Indian Stock Market in Comparison

This article evaluates the impact of financial liberalisation on the growth, development and efficiency of the Indian stock market vis-à-vis other select Asian markets. Though the expansion of the Indian stock market in the post-liberalisation period is truly impressive, in terms of quality there has been a regress. Trading has become increasingly concentrated in some sectors and companies, and the higher volatility in the market, without a corresponding higher return, portends greater risk and more instability for investors.

Indian Stock Market in Comparison

This article evaluates the impact of financial liberalisation on the growth, development and efficiency of the Indian stock market vis-à-vis other select Asian markets. Though the expansion of the Indian stock market in the post-liberalisation period is truly impressive, in terms of quality there has been a regress. Trading has become increasingly concentrated in some sectors and companies, and the higher volatility in the market, without a corresponding higher return, portends greater risk and more instability for investors.


uring the late 1980s, developing countries started liberalising their financial sectors. The concept of financial liberalisation became a new orthodoxy among the major international institutions that offer policy guidelines for developing countries, which hastened the process of deregulation of financial system in many less developed countries (LDCs). One distinguishing feature of financial liberalisation, in relation to financial sector reforms, suggests the abolition of institutional nominal interest rates that are held below their equilibrium level in order to raise savings, investments and growth.


Financial markets, especially stock markets, have grown considerably in developed and developing countries over the last two decades. Better fundamentals (higher economic growth, more macro stability, structural reforms (notably privatisation of state-owned enterprises) and specific policy changes (notably domestic financial reforms and capital account liberalisation) have aided in their growth. Thanks to financial liberalisation, Indian stock market, like many other markets of developing countries, underwent tremendous changes from 1991, when the government has adopted liberalisation policies more seriously than ever before. As a result, there can be little doubt about the growing importance of the stock market from the point of view of the aggregate economy. Stock market liberalisation is a decision by a country’s government to allow foreigners to purchase shares in that country’s stock market. The standard international asset pricing models (IAPMs) predict that stock market liberalisation may reduce the liberalising country’s cost of equity capital by allowing for risk sharing between domestic and foreign agents

Economic and Political Weekly May 6, 2006 [Henry 2000]. There is almost unanimity among academics (Grabel, etc) that financial liberalisation encourages the formation of equity markets where they did not exist previously, and helps in their deepening and widening where they predated the reforms. The expansion of equity markets of many Asian countries after liberalisation is truly impressive [Clemente 1994]. Some of these markets are even comparable in size to the smaller European markets and many of them have been growing at a faster rate than European markets over the last few years and are likely to continue to do so. However, all these encouraging developments in the emerging markets have been largely overshadowed by an excessive fluctuation of share prices [Roy 1999].

Against this backdrop, this article evaluates the impact of financial liberalisation on the growth, development and efficiency of the Indian stock market vis-à-vis other select Asian markets.

In this study, an effort has been made to assess the impact of financial liberalisation on the growth and development of the Indian stock market vis-à-vis select Asian countries by a comparative analysis. The Asian countries have been selected on the basis of their official liberalisation dates, which are more or less close to that of the India and to availability of data for the countries selected.

The data related to Indian stock markets for the period 1991-92 to 2004-05 used in this study have been collected from secondary sources, i e, Securities Exchange Board of India (SEBI) Annual Report, Bombay Stock Exchange (BSE) Annual Report, Reserve Bank of India (RBI) Bulletin, Monthly BSE Review and SEBI Monthly Bulletin. On the other hand, data related to select Asian countries have been collected mostly from World Federation of Exchanges Annual Report and Standard and Poor’s (S&P) Emerging Stock Market Factbook. Besides these, other sources are acknowledged as and when data from such sources are used in the paper.

Development of Stock Markets

Financial sector reform in India has been successful in bringing significant improvements in various market segments by effecting regulatory and legal changes, building up institutional infrastructure, constant fine tuning in the market microstructure and substantial upgradation of technological infrastructure. One of the aims of these changes was to provide that in the absence of a well-functioning necessary impetus to the development of stockmarket, firms are unable to optimally stock market functioning in India. Econo-structure their financing packages. Third, mies without a well-functioning stock stock markets play an important informarket may suffer from three types of mational role. Well-functioning stock imperfections. First, if there is no stock markets collect information about the prosmarket, or the stock market is not ad-pects of firms whose shares are traded, and equately liquid, opportunities for risk make it available to creditors and invesdiversification are limited for investors tors. By improving the flow of information and entrepreneurs. The high costs of about firms and simplifying takeovers, diversification may induce firms to avoid well-functioning stock markets may conthe use of financial markets and may tribute to corporate control and thus lead influence the firms’ investment decisions. to greater managerial competence. Better Thus, firms may choose less capital-corporate control and firm management will, intensiveproduction technologies that are in turn, promote investment and efficiency. subject to lower long-term risk, or they Realising the multi-pronged benefits that may invest less and remain smaller than could be derived from stock market, steps if their shares were widely held. Second, were taken to reform the Indian stock

Table 1: Select Indian Stock Market Development Indicators

Year Market Gross No of FII Net BSE P/E Market Turnover Value-
Capitalisation Annual Turnover Listed Com- Investment Sensex Ratio Capitalisation Ratio Traded Ratio
(Rs in (Rs in panies in India Ratio
Crore) Crore) (Rs in Crore)
1991-92 323363 71777 N A N A 1879.51 44.3 54.89 22.19 12.18
1992-93 210952 45696 2861 13.4 2895.67 29.3 31.33 21.66 6.79
1993-94 398432 84536 3858 5126.2 2898.69 46.8 50.99 21.22 10.82
1994-95 468837 67749 4702 4796.3 3974.91 30.4 51.12 14.45 7.39
1995-96 563748 50063 5603 6942 3288.68 17.3 52.53 8.88 4.66
1996-97 505137 124284 5832 8574.2 3469.24 14.6 40.62 24.60 9.99
1997-98 630221 207644 5853 5957.4 3812.04 15.2 40.31 37.06 14.94
1998-99 619532 311999 5849 -1584.4 3294.78 14.6 34.13 57.21 19.52
1999-00 912842 685028 5815 10121.9 4658.63 22.7 51.99 75.02 39.02
2000-01 571553 1000032 5869 9934.3 4269.69 19.7 30.15 174.97 52.75
2001-02 612224 307292 5782 8755.2 3331.95 16.33 29.43 50.19 14.77
2002-03 570568 314073 5650 2688.6 3206.29 14.26 25.59 54.89 14.05
2003-04 1201206 503053 5528 45765 5590.60 18.15 76.00 41.88 32.25
2004-05 1698428 518715 4731 45881 6492.79 14.96 54.64 30.54 16.69

Notes: Market capitalisation ratio represents market capitalisation as percentage of GDP at market prices. Turnover ratio represents value of total shares traded as percentage of market capitalisation. Value-traded ratio represents as total value traded percentage of GDP.

Source: Compiled from different issues of SEBI Annual Report, RBI Annual Report, Monthly Bombay Stock Exchange.

Table 2: Stock Market Indicators of Select Asian Markets

Country Market Capitalisation No of Listed Companies (in US $) Official 1981 1996 2004 1981 1996 2004 Liberalisation Date

India November 1992 6649 122605 386321 2114 2261 4730 Indonesia September 1989 74 91016 73251 8 253 331 Malaysia December 1988 10100 307179 181624 187 621 955 South Korea January 1992 4224 138817 389473 343 760 683 Thailand September 1987 N A 99828 115390 N A 454 463 Taiwan January 1991 5312 273608 441436 107 382 697

Source: Compiled from different issues of Annual Report, World Federation of Exchanges, S&P Emerging Stock Market Factbook.

Table 3: Stock Market Development, International Comparison, End 2003

US UK Japan Germany Singapore Hong Kong China India

No of listed companies 5295 2311 3116 684 475 1029 1296 5644
Market capitalisation ($ bn) 14266 2412 3041 1079 145 715 681 279
MC ratio (per cent) 139.8 159.7 70.3 57.5 168.4 426.4 55.2 56.4
Turnover ($ mn) 15547 2151 2273 1147 88 332 477 285
Turnover ratio (per cent) 122.8 100.6 88.0 130.0 71.1 56.3 83.3 138.5
Note: MC represents market capitalisation.
Source: S&P Emerging Stock Market Factbook, 2004.

Economic and Political Weekly May 6, 2006

market. The financial liberalisation added much-needed tempo to the development of the Indian stock market. It also brought about a series of changes, both quantitative and qualitative, in operational activities, which was not possible in the preliberalisation period. All stock market indicators that financial economists favour to measure the growth and development of the market, e g, market capitalisation, gross annual turnover, number of listed companies, P/E ratio, etc, started behaving well with the regime shift. Table 1 shows the pattern of changes of the Indian stock market with the gradual deregulation of the Indian economy.

This phenomenal change in the fortunes of the secondary markets in India has come about by the introduction of online trading, rolling settlement, electronic shares, and increased Foreign Institutional Investors (FIIs) participation. A comparative analysis of the experiences of select Asian emerging countries also confirms the view that financial liberalisation helped in the development of stock markets (Table 2). The recovery from the Mexican crisis of 1994 in emerging equity markets in 1996 was accompanied by increased liquidity in most markets as turnovers rose but new issuance remained subdued. The market capitalisation of emerging market countries has more than doubled over the past decade, growing from less than $ 2 trillion in 1995; it is set to exceed $ 5 trillion in 2006. As a percentage of world market capitalisation, emerging markets are now more than 12 per cent and steadily growing (Standard & Poor’s Global Stock Markets Factbook, 2005).

It is interesting to note that all the stock market indicators in India showed an increase up to 1999-2000 but nosedived afterwards. The reason for this fall after 1999-2000 could be the effects of the Mexican crisis in 1994, east Asian turmoil in 1997-98 and the global economic slowdown during 2000, all of which also affected the Indian market.

Moreover, to examine the impact of financial liberalisation on the size and liquidity of the stock markets, different stock market development indicators are available. To measure the size of the stock market, the market capitalisation ratio (MR), which equals the value of listed domestic shares on domestic exchanges divided by gross domestic products (GDPs), is one of the widely used indicators. Besides, to measure the stock market liquidity turnover ratio (TR) is important. The TR equals the value of trades of domestic shares on domestic exchanges divided by the value of listed domestic shares. The TR measures the volume of domestic equities traded on domestic exchanges relative to the size of the market. High turnover is often used as an indicator of low transaction costs. Levine (1996) argued that countries may be able to garner big growth dividends by enhancing the liquidity in their stock markets. Apart from these, the value traded ratio (VR) may also be considered to measure trading volume as a share of national output, and should therefore positively reflect liquidity on an economy-wide basis [Levine and Zervos 1998]. The VR is calculated by dividing the value of the trades of domestic shares on domestic exchanges by GDP. Table 1 shows that India’s MR was on the rise until 1999-2000 and, after a marginal fall, it recovered gradually. In comparison, TR showed a somewhat spectacular rise in the post-liberalisation era. But VR went through a roller-coaster ride. In the postliberalisation period, the Indian stock market especially now is comparable to many developed markets in terms of a number of parameters. The market capitalisation ratio compares favourably even with advanced countries and is much better than emerging markets. At the end of 2003, Standard and Poor’s (S&P) ranked India 17th in terms of market capitalisation, 16th in terms of total value traded in stock exchanges and 6th in terms of turnover ratio. There are very few countries that have a higher turnover ratio than India. India ranks second in the number of listed securities on the exchange after USA. The 142 Indian stocks, which accounted for 66.4 per cent of market capitalisation and 74.1 per cent of the total value traded, had a

5.78 per cent weight in International Finance Corporation (IFC) Global Composite Index of emerging market stocks. In the case of the IFC Investable Composite Indices, which include the emerging market stocks that are determined by the IFC to be legally and practically available to foreign portfolio investors, India’s share was only

2.31 per cent by the end of 2003 (Table 3).

Furthermore, a comparison of stock market operational indicators in India and select Asian countries also reveals some glaring facts. The average price-earning (P/E) ratio in the Indian market (BSE) was more than that of South Korea, Indonesia and Thailand, but quite below than that of Taiwan and Malaysia. Valuations for the Indian market are increasingly seen as being on the higher side, measured by their priceearnings ratios vis-à-vis Asian peers. From Table 4 it was also observed that as far as new capital raised, total market returns and average daily turnover, were concerned, the Indian market did extremely well as compared to its counterparts. But in terms of the average value of transactions and turnover velocity, the position of the Indian stock market was not at all encouraging (Table 4).

In the Indian context, in terms of high turnover and high liquidity in the secondary market, what is actually claimed may be far from true. Following policy reforms, the turnover in BSE has increased manifold, but out of the nearly 5,650 listed companies, the largest 500 companies in terms of market turnover account for about

Table 5: Stock Index Daily Return Average and Volatility (Per Cent)

Bombay Stock Exchange Sensitive Index (BSE Sensex) Year Mean Standard Skewness Kurtosis Deviation

1991 0.12 2.23 -1.09 9.19 1992 0.11 3.45 0.01 2.26 1993 0.08 2.11 -1.67 11.32 1994 0.07 1.44 0.57 1.99 1995 -0.15 1.32 0.00 0.35 1996 0.01 5.9 0.42 0.81 1997 0.03 1.68 -0.28 4.05 1998 -0.11 1.99 0.12 1.54 1999 0.19 1.82 0.60 2.24 2000 -0.12 2.22 -0.25 0.92 2001 -0.09 1.75 -0.50 1.76 2002 0.02 1.11 0.18 1.51 2003 0.24 1.18 -0.19 0.05 2004 0.04 1.61 0.16 1.63

Source: SEBI Monthly Bulletin, October 2004.

Table 4: Key Stock Market Indicators of Select Asian Markets*

India South Korea Taiwan Malaysia Indonesia Thailand

P/E ratio 15.85 14.0 28.62 18.81 8.53 27.94
Total market returns (per cent) 13.57 12.07 5.57 12.77 NA 42.53
New capital raised (US $ bn) 2859.93 9245.17 9272.2 2364.93 1090.23 3331.85
Average daily turnover (US $ mn) 363.13 2088.37 2602.2 197.87 75.5 352.73
Average value of transactions
(US $ mn) 0.5 3.3 3.8 2.7 4.53 3.2
Turnover velocity of domestic
shares (per cent) 39.03 198.33 195.13 31.0 40.47 112.4
Notes: NA: Not available.
*Averaged over 2002 to 2004.
Source: World Federation of Exchanges, Annual Report, 2004.

Economic and Political Weekly May 6, 2006 99 per cent of the turnover. Again, in the Indian stock market, out of nearly 7,000 listed stocks, as many as 4,000 are thinly traded or lack liquidity. The recent figures indicate that in 1999-2000, the percentage of non-traded scrips at BSE was 52.94. The percentage of non-traded scrips at the BSE rose to 65.46 per cent during 2004-05. Some other facts worth mentioning are that

8.8 per cent of the companies listed on the BSE traded for less than 10 days during 2002-03, while 32.2 per cent of the stocks were traded for less than 100 days. This highlights the fact that a handful of concentrated shares are being traded at high demand and, for the rest, the demand is either marginal or zero.

Considering all aforementioned stock market development indicators, it may be argued that domestically, financial liberalisation helped to develop the size and liquidity of the Indian stock market. However, in comparison to other developed and emerging stock markets, the Indian market is still lagging behind. The question that remains is how this development has helped to enhance the efficiency of the Indian stock market. Market efficiency is generally judged by the asset price volatility exhibited by a market. As already pointed out, Indian markets suffer from the menace of over-speculation and excessive price fluctuation that is more fierce than many of its counterparts. So, in the following section we seek to find out answers to some relevant questions: What is the impact of the regime shift on asset price volatility in Indian stock markets? What are the experiences of select Asian markets in this regard?

Share Price Volatility

The efficient market theory argued that all share price movements must be interpretable by the flow of information about economic fundamentals. If the share price changes in response to fundamental economic factors, or because of information and expectation about them, prices will always be in “equilibrium” [Roy 2001]. Markets with severe price swings can be hardly explained by fundamental economic factors.

Volatility of a stock measures the frequency with which changes in its market price take place over a period of time. If a stock is highly volatile, that is, if there are large fluctuations in its prices, riskaverse investors might avoid participating in the market. On the other hand, if prices are often swayed by “animal spirits”, a big rise and fall in share prices may make investors anxious about the prospects of their investments.

As a concept, volatility is simple and intuitive. It measures the variability or dispersion about a central tendency. It is a measure of how far the current price of an asset deviates from its average past price. The greater this deviation, the greater is the volatility. The magnitude of asset price fluctuations is commonly measured in terms of standard deviation.

The theory of financial liberalisation predicts a decrease in volatility in asset price, restrains excessive speculation in the post-reform period and discounts its macroeconomic effects [Grabel 1995]. Moreover, it is argued that a liquid market should be able to handle heavy trading without much price volatility [Levine 1996].

In the post-reform period, the share price volatility exhibited by the Indian market is quite alarming. It seems that a sober


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Economic and Political Weekly May 6, 2006

market underwent a volte-face overnight. Table 5 shows details of daily mean return, daily standard deviation, skewness and kurtosis for the Indian stock market over a 14-year period from 1991 to 2004. A close look at Table 5 reveals that India did show the highest volatility in 1992 at 3.45 per cent followed by 2.23 per cent in 1991 and recorded the lowest volatility in 2002 at 1.11 per cent, followed by 1.18 per cent in 2003, 1.32 per cent in 1995.

The daily average return and average volatility are useful to policy-makers, regulators, market participants and even investors. Furthermore, Indian market indices showed very high stability and normality. Both skewness and kurtosis are relatively low. In the years 1997 and 1998, the third and fourth order moments are comparatively low. Like other markets, India also experienced quieter moments from 1999 to 2003. It may be possible to conclude that the Indian market exhibited less asymmetry in the entire period [Raju and Ghosh 2004]. A comparison of return and volatility behaviour between India and select Asian countries are provided in Table 6.

From Table 6 it is evident that for 19841991, Indian market exhibited the highest volatility (1.97) with return 0.08, skewness negative and kurtosis 3.86. During the same period, all other Asian markets registered comparatively less volatility, but higher return. Interestingly, for 1992-2002 Indian market recorded a lower volatility than that of the previous time span with mean zero, negative skewness and higher kurtosis. Moreover, it is interesting to note that for whole time period 1984-2002, the Indian market exhibits a higher volatility than other countries with negative skewness and kurtosis being 4.66. Negative skewness and high kurtosis are extremely harmful to the investors in the long run. Traditionally, market watchers see the high volatility as a sign of investor nervousness which, in the counter-intuitive world of markets, is bullish. Conversely, low volatility is viewed as a sign of investor confidence or even complacency and the warning of a market downturn (ibid 2004). The higher expected returns on equity in emerging markets relative to mature markets have been associated with a generally higher price and return volatility. The volatility in emerging equity markets rose steadily during 1994 in the run-up to the Mexico crisis, plateauing at a considerably higher level during 1995. The volatility in Asian markets rose from 1.5 per cent in late 1993 to 3 per cent by mid-1995. Then volatility declined dramatically during the course of 1996 and continued doing so through May 1997, with that in Asia returning to its previous low of 1.50 per cent. By mid-1997 these volatilities were comparable to, and in fact, slightly below, those in the mature equity markets. This situation changed drastically in the second-half of 1997, as the volatility of returns on Asian emerging markets rose steeply. Global investors explore emerging markets in search of higher returns and also to reduce risk through portfolio diversification. However, cross-border flows entail a possible contagion in the event of financial turbulence.

Developed markets, in general, had less annualised volatility during 2004-05 compared to the volatility exhibited by emerging market economies. The highest volatility among developed markets was observed in Nasdaq (15.7 per cent) followed by Hang Seng Index (15.1 per cent) and the lowest volatility in AS30 Index of Australia (6.8 per cent). Among the emerging economies, Russia witnessed the highest annualised volatility of 36.4 per cent while Malaysia had the lowest volatility of 10.2 per cent.

Table 6: Return and Volatility Behaviour: Select Asian Countries

Country Period Observations Mean Standard Deviation Skewness Kurtosis
(Per Cent) (Per Cent)
India 1984-1991 1448 0.08 1.97 –0.33 3.86
1992-2002 2460 0.00 1.94 –0.13 5.18
1984-2002 3908 0.03 1.95 –0.20 4.66
South Korea 1984-1991 2344 0.07 1.16 0.20 2.12
1992-2002 2979 0.00 1.97 –0.14 3.05
1984-2002 5323 0.03 1.66 0.13 4.23
Taiwan 1992-2002 2465 –0.02 1.28 0.10 2.45
Malaysia 1984-1991 1992-2002 1958 2713 0.02 0.01 1.55 1.65 –1.67 0.66 21.94 18.74
1984-2002 4671 0.01 1.61 –0.21 19.94
Indonesia 1984-1991 1947 0.06 1.76 7.68 187.23
1992-2002 2686 0.02 1.57 –0.72 13.31
1984-2002 4633 0.03 1.56 3.55 107.96
Thailand 1984-1991 1084 0.08 1.94 –1.14 10.31
1992-2002 2699 –0.03 1.70 0.10 4.01
1984-2002 3783 0.00 1.77 –0.35 6.60

Source: SEBI Annual Report, 2002-03.

A comparative picture of annual returns on indices vis-à-vis annualised volatility is examined. It is evident from that among developed markets, with a low volatility of 6.8 per cent, Australia posted a healthy return of 20 per cent. However, Hong Kong with a volatility of 15.1 per cent could provide only a 6.6 per cent index return on a yearon-year basis. In emerging markets, the index returns trace a volatile pattern with the China SHCOMP index sliding by 32.2 per cent with an annualised volatility of

20.4 per cent. In case of India, both Sensex and Nifty posted positive returns of 16.1 and

14.9 per cent, respectively, with annualised volatility of 23.8 and 26.1 per cent. The correlation coefficient between volatility and annualised return from a sample of 19 countries worked out to be negative (–0.43) [SEBI Annual Report, 2004-05].


There is no denying that financial liberalisation has had a beneficial impact on the growth and development of the Indian stock market. It has developed substantially since 1991-92 in terms of conventional and qualitative indicators and it has become larger in size and more liquid in the post-liberalisation period. The expansion of the Indian stock market in the postliberalisation decade is truly impressive.

But in terms of quality, there has been a regress. In the post-reform era, trading in the Indian stock market became increasingly concentrated in a few sectors and companies; the increase in annual turnover is mainly attributable to this greater concentration on a few companies and sectors. As far as allocative efficiency is concerned, it is confined to only a few liquid shares and the bulk of non-specified shares do not have that much of marketability, which rather reflects the sheer misallocation of funds. Moreover in respect of volatility, the market does not exhibit any radical change. The higher volatility exhibited by the Indian market without a corresponding higher return, negative skewness and higher kurtosis portends higher risks and more instability for investors. The excessive share price fluctuations in the Indian equity market would obviously not encourage retail investors to enter the fray. If the price of shares is “noise-driven” rather than “news-driven” there will be fluctuations in share prices. Noisy price movements impart pseudo-signals to investors about the efficiency of firms, which results in the misallocation of scarce resources of society.

Economic and Political Weekly May 6, 2006

The guiding objectives of stock market liberalisation in several countries, including India, were to improve the mobilisation of scarce resources from domestic, regional and international sources and allocation of the same for productive investments. A market plagued with severe price volatility can hardly achieve the desired objectives. If the market fails to discharge these avowed objectives, the programme of financial liberalisation, to say the least, will suffer a big jolt in the emerging markets and they will be more exposed to the vagaries of financial crises.




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Emerging Equity Market’, The Colombia

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Grabel, Ilene (1995): ‘Assessing the Impact of Financial Liberalisation on Stock Market Volatility in Selected Developing Countries’, The Journal of Development Studies, Vol 31, No 6, August, pp 903-17.

Henry, Peter Blair (2000): ‘Stock Market Liberalisation, Economic Reform and Emerging Market Equity Prices’, Journal of Finance, Vol LV, No 2, April, pp 529-64.

Levine, Ross (1996): ‘Stock Markets: A Spur to Economic Growth’, Finance and Development, March, Vol 33, No 1.

Levine, Ross and Sara Zervos (1998): ‘Stock Markets, Banks and Economic Growth’, The American Economic Review, Vol 88, No 3, June, pp 537-58.

Raju, M T and Anirban Ghosh (2004): ‘Stock Market Volatility: An International Comparison’, SEBI Monthly Bulletin, Vol 2, No 5, May, pp 9-22.

Roy, M K (1999): ‘Financial Liberalisation and Stock Market Behaviour: Experiences of India and Select Asian Countries’, Review of Development and Change, Vol IV, No 2, July-December, pp 225-36.

–(2001): ‘Stock Market in a Liberalised Economy: Indian Experiences’, Economic and Political Weekly, Vol 36, No 4, January, pp 367-76.

Economic and Political Weekly May 6, 2006

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