Importance of capital market

An efficient capital market is an essential pre-requisite for industrial and commercial development of a country. An organized and well-developed market operating in a free market economy ensures the best possible co-ordination and balance between the flow of savings on the one hand and the flow of investment leading to capital formation on the other. It also directs the flow of savings into most profitable channels and thereby ensures optimum utilization of financial resources.

The importance of capital market in the process of economic development of a country can be described as below:

1. Mobilizing Savings: The capital market plays a vital role in mobilizing savings to put it in productive investment, so that the development of trade, commerce and industry could be facilitated. In this process the capital market helps in the process of capital formation and hence the economic development. The capital market acts as a bridge, between savers and investors.

2. Stability in Value: In case of a developed capital market, the experts in banking and non-banking intermediaries put in every effort in stabilizing the values of stocks and securities. This process is facilitated by providing capital to the needy at a lower rate of interest and by cutting down the speculative and unproductive activities.

3. Encouragement to Economic Growth: The process of economic growth is made easier through the capital market. The various institutions of the capital market give quantitative and qualitative direction to the flow of funds. The proper flow of funds leads to the development of commerce, trade and industry.

4. Inducement to Savings: Savings are the backbone of any nation’s economic development. If capital markets are developed in less developed areas, people will get induced to save more because savings are facilitated by banking and non-banking financial intermediaries.

Thus, it is clear that the capital market is the life-blood of economic development of a country. If the capital market is not developed, it will lead to misuse of financial resources. The capital market plays a significant role in diverting the wrongful use of resources to their rightful use.

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Meaning of Capital Market

The term “Capital Market” is used to describe the institutional arrangements for facilitating the borrowing and lending of long-term funds. Usually, stress is laid on the markets for long term debt and equity claims, government securities, bonds, mortgages, and other instruments of long-term debts. Thus, the capital market embraces the system through which the public takes up long-term securities, either directly or through intermediaries. It consists of a series of channels through which the savings of the community are mobilized and made available to the entrepreneurs for undertaking investment activities.

Conventionally, short-term credit contracts are usually classified as money market instruments, while long-term debt contracts and equities are regarded as capital market instruments. In practice, however, there is a thin line of demarcation between the money market and the capital market, because quite often, the same institutions participate in the activities of both the markets, and there is flow of funds between the two markets.

The major functions performed by a capital market are as follows:

(a) Mobilization of financial resources on a nation-wide scale.

(b) Securing the foreign capital and know how to fill up the deficit in the required resources for economic growth at a faster rate.

(c) Effective allocation of the mobilized financial resources by directing the same to projects yielding highest yield or to the projects needed to promote balanced economic development.

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