The Financial Express

Capital market and central bank

| Updated: October 19, 2020 21:14:14

Lankabangla and Fianancial Express Lankabangla and Fianancial Express
Capital market and central bank

A general increase in the economic activity of a country may lead to the spring up of industries. However, a well-developed system is needed to raise funds for economic growth. This has led to the establishment of stock exchange market in many countries including Bangladesh. Thus, stock exchange becomes the centre point of the capital market. Our government also recognises the need for an efficient stock exchange in the country. Therefore, a solid foundation is needed for the operation of the capital market with a view to trading in securities (long-term nature) for financing industrial sector and the economy. The capital market is an economic indicator showing performance of government policies. It plays a crucial role in the economic development of a country and the central bank tries to expand the investor base in a country. So, the role of central bank on the financial market and the development of the capital market is very positive and significant.

A capital market is for resource intermediation for the financial market in which medium and long-term credit is available for economic development. This market is for long-term company loan capital and share capital and government bonds. Those who are in short of fund and need to borrow for long-term purposes and those who have fund surplus and wish to lend or invest over long periods are of great concern to capital market. This is known as financial intermediary. Eventually, the capital market together with the money market (provides short-term funds) is the main source of external finance to industry and government. In the same way the financial institutions like the central bank, commercial banks, the saving investing institutions (insurance companies, pension funds, etc.), issuing Houses, and merchant banks are all involved in the capital market.

The efficiency and the development of the capital market is dependent on the role of the central bank which can ensure properly structured market to serve the private and public interest as well as to protect local and foreign investment. Likewise, the role of the central bank in the capital market is also significant to ensure up-to-date infrastructural development and guarantee for sustainable economic security and inflow of foreign investment. Therefore, this kind of role in the capital market development can be analysed through the parameter of efficiency in the market in terms of safety and protection of investment, general growth of the market, as well as the economic system. As a result, the central bank, as the apex banking authority, monitors the activities and development of the capital market.

Unquestionably, the performance of the capital market shows the state of a country's economy. When stock prices start to fall, economic depression arises and on the other hand, rising stock prices show possible economic growth. Regarding this issue, RBI (Reserve Bank of India) Deputy Governor Viral V Acharya reasonably said "Capital markets provide financial resources for the long-term sustainable development of the economy, so it is considered an important element in the macro-financial policy toolkit". Thus central bank can create an enabling environment with the macroeconomic stability factors in association with stable growth and low inflation.

Central bank can also influence money supply in the economy through open market operations as it can buy and sell G-Secs (government securities). The intervention through open market operations can also influence foreign exchange market and exchange rate. For example, the People's Bank of China and the Bank of Japan bought several hundred billions of U.S. Treasuries in order to stop the decline of the U.S. dollar versus the renminbi and the yen.

A working group created in Global Financial System (CGFS) in 2018-19, after examining global trends in capital market development, identified two types of drivers of capital market development. One is creating an enabling environment for financial development and the second is capital market-specific easy access to high-quality material information, diversity in investor base and efficient market system for trading. Thus, encouragement of market autonomy through updated and efficient regulatory guidelines and procedures, development of financial market institutions and infrastructure as well as macro-prudential management of investment restrictions for domestic and foreign investors are the factors of the policies to develop the capital market in a country.

We know that the capital market is a financial market where medium- and long-term debt instrument are traded. Similarly, as the capital market is an economic symbol that represents the total economic activity of a country, thus the various factors affecting the capital market needs to be identified so that good investments take place within suitable opportunities. Industries need to have confidence in the capital market to sourcing long term funds at a considerably low rate compared to the traditional banking system credit.

Although there is a negative relationship between monetary policy rate and performance of the capital market, a positive and significant relationship also exists between cash reserve ratio and capital market performance. When monetary policy variables are held constant, performance of the capital market can improve. Thus a unit increase in monetary policy rate may result in depreciation in performance of the capital market, while a unit increase in cash reserve ratio may rise in capital market performance. Research reveals that certain variation in capital market performance can take place as a result of fluctuations in monetary policy instruments. Therefore, monetary policy rate and cash reserve ratio may not sometimes have significant effect on capital market performance, yet it is obvious that the performance of the capital market detects adjustments in monetary policy rate.

The role of monetary policy in financial stability and development is undisputed beyond any doubt. However, the capital market in its developing stage requires careful and appropriate policy implementation by the central bank to improve development and competitiveness in the global economy. Research shows that monetary policy of the central bank with respect to adjustments in monetary policy rate is critical for increasing the depth of development in the capital market and the financial system in general. Generally, high interest rate reduces cash flows of firms quoted in the stock exchange and reduces in the values of securities traded on the market. Therefore, cash reserve ratio should be lowered to improve capital market performance through upward movement in all share index.

Few researchers through their obtained multiple regression results provide evidence that money supply has a remarkable positive impact on capital market while the interest rate exerts a negative effect on the capital market output. It has been revealed further that the exchange rate has an insignificant positive effect on the capital market performance.

As the capital market is pivotal in connecting all aspects of the economy in one place through buying and selling of securities, so central bank has the responsibility to standardise the policies of money supply and control the interest rate. Therefore, the cost of obtaining credit by investors should be minimised to boost capital market efficiency. The money supply should be stable and match with the prevailing economic realities. That means money supply should correspond with the investment needs of the economy. Thus, central bank should come up with strategies to improve the value of the local currency. In that case, a pilot test can be undertaken on all monetary policy adjustments before adoption by the authority concerned in the country.


Salma Nasreen ndc is Independent Director (DSE) and Additional Secretary (Rtd).


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