Money Market :
Meaning : Money market is a market for lending and borrowing of funds for short term. It
is a market wherein lending and borrowing of funds take place for a short period of time
which varies from one day to a year. Also the financial instruments traded in this market
can be converted into cash easily without any loss of time and value. It is an important
part of the financial system that helps in fulfilling the short term and very short term
requirements of companies, banks, financial institutions, government agencies etc. It is
a market for financial assets which are close substitutes for money. The instruments like
commercial paper, treasury bills etc. are traded in the money market.
Features of the Indian Money Market
1. Short-Term Duration of Funds
The Indian money market deals only in short-term borrowing and lending. The maturity
period of instruments traded in this market ranges from one day to a maximum of one
year. It helps banks, financial institutions, companies, and the government manage their
short-term cash needs and maintain liquidity.
2. Wholesale Market
The money market is a wholesale market, meaning that transactions are conducted in
large amounts, usually running into crores of rupees. Because of the large size of
transactions, individual investors generally do not participate. Instead, the market is
dominated by banks, financial institutions, mutual funds, and large corporations.
3. Over-the-Counter (OTC) Market
Trading in the money market does not take place on a stock exchange. Instead, it
operates as an Over-the-Counter (OTC) market, where deals are negotiated directly
between participants. Agreements are usually made through telephone, email, or
electronic trading platforms, and later confirmed through formal documentation.
4. Wide Range of Participants
The Indian money market has many important participants, including the Reserve Bank
of India (RBI), commercial banks, cooperative banks, financial institutions, mutual funds,
primary dealers, and large business firms. Each participant plays a specific role in
ensuring smooth flow of short-term funds.
5. Impersonal Nature of Transactions
Transactions in the money market are impersonal. Deals are based on the financial
credibility and reputation of institutions, not on personal relationships. Standardised
rules, interest rates, and credit ratings guide the transactions, making the market
professional and systematic.
6. No Fixed Geographical Location
The money market does not have a specific physical location like a stock exchange. It is
a network-based market spread across various financial centres such as Mumbai, Delhi,
and Chennai. Transactions are conducted using modern communication systems,
making the market flexible and efficient.
7. High Liquidity and Low Risk
Money market instruments are highly liquid, meaning they can be converted into cash
quickly without much loss. Since the maturity period is very short, the risk involved is
low. However, because of this low risk, the returns are also relatively low compared to
long-term investments.
8. Different Segments and Instruments
The Indian money market consists of several segments, each dealing in different
instruments such as Call and Notice Money, Treasury Bills, Commercial Papers,
Certificates of Deposit, and Commercial Bills. These instruments help meet the diverse
short-term financial needs of different participants.
9. Regulated and Controlled by the RBI
The money market is closely regulated by the Reserve Bank of India. The RBI uses
various monetary policy tools such as repo rate, reverse repo rate, open market
operations, and liquidity adjustment facility (LAF) to control liquidity and maintain
stability in the market.
10. Balances Demand and Supply of Short-Term Funds
One of the main functions of the money market is to bring together lenders and
borrowers of short-term funds. Institutions with surplus funds lend money to those facing
temporary shortages, ensuring efficient use of financial resources in the economy.
11. Foundation for Monetary Policy
Interest rates determined in the money market, such as the call money rate, serve as
key indicators of liquidity conditions. The RBI uses these rates to transmit its monetary
policy and influence lending and borrowing in the overall financial system
12. Facilitates Goverment Borrowing
The money market plays an important role in meeting the short-term financial needs of
the government. The government raises funds by issuing Treasury Bills, which are
considered safe instruments and are actively traded in the money market.
Recent changes and trends in the Indian money
market
In recent years, the Indian money market has experienced several important changes
due to economic conditions, policy decisions taken by the Reserve Bank of India (RBI),
and rapid technological developments. These changes have improved the efficiency,
stability, and accessibility of the money market.
1) Introduction of new instruments:
Treasury bills of varying maturity periods, Commercial Papers (CPs), Certificates of
Deposits (CDs) and Money Market Mutual Funds (MMMFs).
2) RBI Repos and Reverse Repos:
These were introduced under the Liquidity Adjustment Facility (LAF).
3) Market-determined interest rates:
Interest rates were allowed to be largely determined by market forces.
4) Improved payment infrastructure:
National Electronic Fund Transfer (NEFT) and Real Time Gross Settlement (RTGS)
were introduced.
5) Technological upgradation:
Electronic dealing system was introduced to bring about technological upgradation.
Liquidity Management and Volatility
The Reserve Bank of India has been actively managing liquidity in the
banking system. At different times, the system has experienced both excess
liquidity and liquidity shortages. To absorb excess liquidity, the RBI introduced
a temporary Incremental Cash Reserve Ratio (I-CRR) in August 2023. This
measure helped reduce surplus funds in the banking system and stabilise
short-term interest rates.
Repo Rate Stability and Gradual Adjustments
The Monetary Policy Committee (MPC) has followed a cautious approach
towards policy rates to control inflation. Repo rates were kept stable for a long
period to align inflation with the target range. In late 2024 and 2025, the RBI
reduced repo rates slightly to support economic growth, indicating a shift
towards a neutral monetary policy stance.
Increased Focus on Secured Funding
There has been a growing trend towards secured funding in the money
market. Banks increasingly rely on repo transactions backed by government
securities and corporate bonds. Secured funding reduces risk and provides
banks with a reliable source of short-term and medium-term liquidity.
Growth of Digital Transactions
Digitalisation has significantly transformed the Indian money market. The
COVID-19 pandemic accelerated the adoption of digital banking, online
financial services, and electronic trading platforms. This has improved
operational efficiency, transparency, and reduced transaction costs.
Introduction of Tri-Party Repo Trading
An important development was the introduction of Tri-Party Repo trading in
2019, operated by the Clearing Corporation of India Limited (CCIL). In this
system, CCIL acts as a central counterparty and guarantees settlement. This
has enhanced market confidence, liquidity, and efficiency.
Development of New Instruments and Platforms
The RBI continues to introduce new instruments and platforms to improve
short-term fund management. A major recent development is the
establishment of AMC Repo Clearing Limited, which facilitates repo
transactions in corporate bonds and expands liquidity in the corporate bond
market.
Shift in Investor Behaviour
Due to global economic uncertainty and market volatility, investors are
increasingly preferring safer and more liquid instruments. Money market
funds, Treasury Bills, Commercial Papers, and other short-term instruments
have gained popularity as they offer safety and quick liquidity.
Strengthened Regulatory Framework
The regulatory framework of the money market has been strengthened to
ensure transparency and efficiency. The RBI has promoted electronic dealing
systems, improved reporting mechanisms, and imposed stricter regulations
on Non-Banking Financial Companies (NBFCs).
Fluctuation in Short-Term Interest Rates
The Indian money market has experienced fluctuations in short-term interest
rates due to strong credit demand, changes in policy rates, and RBI liquidity
measures. During periods of higher interest rates, instruments such as
Treasury Bills and Commercial Papers have become attractive investment
options.
Capital Market :
Meaning : It is the market for borrowing and lending long term capital required by
business enterprises. The financial assets dealt with in the capital market have long or
indefinite maturity period. The capital market is a core of a country's financial system as
it helps in the mobilisation of resources. As per SEBI, capital market is a market for
long term debt and equity shares. In this market, the capital funds comprising of both
equity and debt are issued and traded. This also includes private placement of debt and
equity as well as organized markets like stock exchanges. One of the important
functions of the capital market is to provide ease of transactions for both the investors
and companies.
FEATURES OF THE CAPITAL MARKET
The capital market is an important part of the financial system that provides long-term
funds to business enterprises and the government. Its main features are as follows:
Link between Investors and Borrowers
The capital market acts as a bridge between investors who have surplus savings
and borrowers who require long-term funds. It mobilises savings and channels
them into productive investments such as industrial development, infrastructure
projects, and business expansion.
Deals in Medium and Long-Term Investments
The capital market deals in financial instruments with a maturity period of more
than one year. It provides stable and long-term finance to companies, industries,
and the government, unlike the money market which deals only with short-term
funds.
Presence of Intermediaries
The capital market functions with the help of several intermediaries such as
brokers, underwriters, merchant bankers, depositories, and custodians. These
intermediaries assist in issuing securities, trading, settlement, and transfer of
ownership, ensuring smooth functioning of the market.
Promotes Capital Formation
By encouraging savings and converting them into investments, the capital market
promotes capital formation. It helps in creating capital assets such as machinery,
factories, and technology, which increases production capacity and supports
economic growth and employment generation.
Regulated by Government Rules and Policies
The capital market is regulated by government rules and regulations to protect
investors and maintain market stability. In India, the Securities and Exchange
Board of India (SEBI) regulates the capital market by ensuring transparency, fair
practices, and preventing fraudulent activities.
Deals in Marketable and Non-Marketable Securities
The capital market deals in marketable securities such as shares, debentures,
and government bonds that can be easily bought and sold in the market. It also
includes non-marketable securities like bank deposits and loans which are not
easily transferable.
Variety of Investors
The capital market includes a wide range of investors such as individual
investors, mutual funds, insurance companies, pension funds, and foreign
institutional investors. This wide participation increases liquidity, improves price
stability, and strengthens the market structure.
Involves Higher Risk
Investments in the capital market involve higher risk due to long-term maturity,
market fluctuations, and business uncertainties. However, higher risk is generally
associated with higher potential returns, making it attractive for long-term
investors.
Provides Liquidity to Investments
The capital market provides liquidity through the secondary market, where
securities can be easily bought and sold. This allows investors to convert their
long-term investments into cash whenever required, increasing investor
confidence and participation.
Facilitates Price Discovery
The capital market helps in determining fair prices of securities through
continuous interaction between buyers and sellers. Prices reflect demand,
supply, and available information, ensuring transparency and efficient valuation
of securities.
Encourages Savings and Investment
The capital market offers various investment opportunities with different risk and
return combinations. This encourages individuals and institutions to save more
and invest their funds productively, contributing to capital formation and
economic development.
Offers Risk Diversification
The capital market provides a wide variety of financial instruments such as
equities, bonds, mutual funds, and derivatives. Investors can spread their
investments across different sectors and instruments, which helps in reducing
overall investment risk.
Promotes Efficient Allocation of Resources
The capital market ensures that financial resources are allocated to sectors and
companies with the highest growth and profitability potential. This leads to
optimal use of funds, promotes innovation and industrial growth, and contributes
significantly to national income and overall economic development.
Recent trends in the capital market
In recent years, the capital market has changed significantly due to technological
advancements, regulatory reforms, and changing investor behaviour. The major
recent trends are explained below.
Reforms Introduced in the Capital Market
1) Establishment of SEBI:
Securities and Exchange Board of India (SEBI) was established in 1988 but given
statutory powers in 1992 to protect the interest of the investors and promote the
development of the securities market.
2) Establishment of National Stock Exchange:
National Stock Exchange (NSE), the leading stock exchange in India was established in
1992.
3) Introduction of Computerized Trading System:
Computerized Screen Based Trading System (SBTS) was introduced as a part of
modernization.
4) Introduction of Demat Account:
Demat account has been introduced since 1996 to facilitate easy purchase and sale of
shares by the investors through the electronic method.
5) Access to Global Funds:
Increased access to global funds by Indian companies was permitted through American
Depository Receipts (ADRs) and Global Depository Receipts (GDRs).
6) Investor Education and Protection Fund:
Investor Education and Protection Fund (IEPF) was established in 2001 to promote
investors' awareness and protecting the interest of the investors.
1. Increase in Retail Investors
The number of individual investors has increased rapidly, especially in India. Easy e-
KYC procedures, online account opening, and mobile trading applications have
encouraged more people to invest. This has strengthened domestic investment and
reduced dependence on foreign capital.
2. Growth of Digital and Online Trading
Capital markets have shifted from physical trading floors to online platforms. Investors
can trade securities through mobile phones and computers anytime and anywhere. This
has improved transparency, liquidity, and overall market efficiency.
3. Use of Artificial Intelligence (AI) and Machine Learning (ML)
AI and ML are widely used for analysing large volumes of data, predicting price
movements, managing risks, and improving customer experience. These technologies
help investors and institutions make quicker and more accurate decisions.
4. Rise of ESG Investing
Environmental, Social, and Governance (ESG) factors are becoming important in
investment decisions. Investors prefer companies that follow ethical, social, and
environmentally friendly practices. This has led to growth in green bonds and ESG-
based mutual funds.
5. Use of Blockchain and Tokenisation
Blockchain technology is being introduced to improve transparency and efficiency in the
capital market. Tokenisation allows fractional ownership of assets like real estate and
commodities, making investment easier for small investors and improving liquidity.
6. Stronger Regulations and Investor Protection
With the rise in retail participation, SEBI has implemented stricter rules to protect
investors. These include higher margin requirements, regulation of broker fees, and
action against unregistered financial influencers to prevent misinformation.
7. Growth of ETFs and Passive Investing
Investors are increasingly preferring low-cost investment options such as Exchange-
Traded Funds (ETFs) and index funds. These instruments offer diversification, stable
returns, and lower management costs.
8. Focus on Cybersecurity
As trading has become digital, protecting investor data is a major priority. Strong
cybersecurity systems are being implemented to prevent fraud, hacking, and data
breaches in the capital market.
9. Global Integration of Indian Capital Market
India’s inclusion in global bond indices has attracted foreign investment. This has
improved liquidity and integrated the Indian capital market with the global financial
system.
What is money supply?
Money supply refers to the total stock of monetary assets or money in circulation within
an economy at a particular point in time. It includes physical currency (notes and coins)
held by the public and various forms of bank deposits that can be easily used for
transactions, investments, and savings. The central bank, in India the Reserve Bank of
India (RBI), is the primary authority that controls and regulates the money supply
through its monetary policy. The term "public" in this context includes all individuals and
business firms but excludes the government and the commercial banking system, which
are considered money suppliers. What is money supply?
Measures of money supply in India
1. M0 (Reserve Money): This is the most basic and easy-to-use form of money. It
includes all the physical cash (notes and coins) circulating in the country, plus the
money that banks keep as deposits with the central bank (RBI), and a few other
minor deposits with the RBI.
2. M1 (Narrow Money): This includes money you can spend immediately. It is the
total of all the cash held by the public plus the money in bank accounts that you
can take out anytime (like checking or standard savings accounts).
3. M2: This measure takes M1 and adds the money people have saved in accounts
at post office savings banks. These savings are slightly harder to access instantly
than M1 money.
4. M3 (Broad Money): This is the main measurement the RBI watches. It combines
M1 with money put into accounts that are locked away for a set time (like fixed
deposits). This money isn't for daily spending but is available for longer-term
needs.
5. M4: This is the biggest measure of all money available. It includes M3 plus every
single deposit people have in post office savings systems (except for specific
government savings certificates).
There are two main types of taxes. They are:
1. Direct Tax:
It is paid by the taxpayer on his income and property. The burden of tax is borne
by the person on whom it is levied. As he cannot transfer the burden of the tax to
others, the impact and incidence of direct tax fall on the same person.
For example, personal income tax, wealth tax, etc.
2. Indirect Tax:
It is levied on goods or services. It is paid at the time of production or sale and
purchase of a commodity or a service. The burden of an indirect tax can be
shifted by the taxpayer (producers) to other person or persons. Hence, the
impact and incidence of tax are on different persons.
For example, Goods and Services Tax (GST) in India has replaced almost all
indirect taxes, customs duty.
Sources of Public Revenue
Public revenue received by the government from administration, public enterprises, gifts
and grants, etc., is called non-tax revenue. These sources are different from taxes. A
brief information about these sources is as follows:
1) Fees:
A tax is paid compulsorily without any return service, whereas a fee is paid in return for
certain specific services rendered by the government. For example, education fee,
registration fee, etc.
2) Prices of Public Goods and Services:
Modern governments sell various types of commodities and services to the citizens. A
price is a payment made by the citizens to the government for the goods and services
sold to them. For example, railway fares, postal charges, etc.
3) Special Assessment:
The payment made by the citizens of a particular locality in exchange for certain special
facilities given to them by the authorities is known as special assessment. For example,
local bodies can levy a special tax on the residents of a particular area where extra or
special facilities of roads, energy, water supply, etc., are provided.
4) Fines and Penalties:
The government imposes fines and penalties on those who violate the laws of the
country. The objective of the imposition of fines and penalties is not to earn income, but
to discourage the citizens from violating the laws framed by the government. For
example, fines for violating traffic rules. However, the income from this source is small.
5) Gifts, Grants and Donations:
The government may also earn some income in the form of gifts by the citizens and
others. The government may also receive grants from foreign governments and
institutions for general and specific purposes. Foreign aid has become an important
source of development finance for a developing country like India. However, this source
of revenue is uncertain in nature.
6) Special Levies:
This is levied on those commodities, the consumption of which is harmful to the health
and well-being of the citizens. Like fines and penalties, the objective is not to earn
income, but to discourage the consumption of harmful commodities by the citizens. For
example, duties levied on wine, opium and other intoxicants.
7) Borrowings:
The government can borrow from the people in the form of deposits, bonds, etc. It also
gets loans from foreign governments and organizations such as IMF, World Bank, etc.
Loans are becoming more and more popular source of revenue for the governments in
the modern times.
Public Expenditure:
Public expenditure is that expenditure which is incurred by the public authority (Central,
State and Local Bodies) for protection of their citizens, for satisfying their collective
needs and for promoting their economic and social welfare.
Till 20th century, the majority of the governments had adopted a policy of laissez faire.
Under this policy, the functions of government were restricted to the obligatory
functions. But, the modern governments not only perform the obligatory functions such
as defence and civil administration, but also perform optional functions for promoting
social and economic development of their countries. Therefore, study of public
expenditure is an important part of study of public finance.
Classification of Public Expenditure:
Different economists have classified public expenditure on different bases. We shall
now study some of the important classification of public expenditure.
A) Revenue Expenditure:
Revenue expenditure of the government is incurred for carrying out day-to-day functions
of the government departments and various services. It is incurred regularly. For
example, administration costs of the government, salaries, allowances and pensions of
government employees, medical and public health services etc.
B) Capital Expenditure:
Capital expenditure of the government is expenditure for progress and development of
the country. For example, huge investments in different development projects, loans
granted to the state governments and government companies, repayment of
government loans etc.
C) Developmental Expenditure:
Developmental expenditure is productive in nature. The expenditure which results in
generation of employment, increase in production, price stability etc. is known as
developmental expenditure. For example, expenditure on health, education, industrial
development, social welfare, Research and Development (R & D) etc.
D) Non-Developmental Expenditure:
On the other hand, that government expenditure which does not yield any direct
productive impact on the country is called non-developmental expenditure. For
example, administration costs, war expenditure etc. These are unproductive in nature.
Reasons for Growth in Public Expenditure:
It is observed that there is a continuous growth in public expenditure in a developing
country like India.
Let us study some of the important reasons:
1) Increase in the Activities of the Government:
As mentioned earlier, the modern government performs many functions for the social
and economic development of the country. These functions include spread of education,
public health, public works, public recreation, social welfare schemes etc. It is observed
that new functions are continuously being undertaken and old functions are being
performed more efficiently on a large scale by the government. This leads to increase in
public expenditure.
2) Rapid Increase in Population:
Population of developing countries like India is increasing fast. In 2011 Census, it was
121.02 crores. As a result, the government has to incur greater expenditure to fulfil the
needs of the increasing population.
3) Growing Urbanization:
Spread of urbanization is a global phenomenon of the day. This leads to increase in the
government expenditure on water supply, roads, energy, schools and colleges, public
transport, sanitation etc.
4) Increasing Defence Expenditure:
In modern times, defence expenditure of the government is increasing even in the
peace time due to unstable and hostile international relationships.
5) Spread of Democracy:
Majority of the countries in the world are democratic in nature. A democratic form of
government is expensive due to regular elections and other such activities. This results
in the increase in total expenditure of the government.
6) Inflation:
Just like a private individual, the government has to buy goods and services from the
market for the spread of economic and social development. Normally, prices show a
rising trend. Due to this, the government has to incur increasing costs.
7) Industrial Development:
Industrial development leads to an increase in production, employment and overall
growth in the economy. Hence, the government makes huge efforts for implementing
various schemes and programmes for industrial development. This results in increase in
government expenditure.
8) Disaster Management:
Many natural and man-made calamities like earthquakes, floods, cyclones, social unrest
etc. are occurring more frequently. The government has to spend a huge amount for
disaster management which increases total expenditure.
Modern governments are working for a welfare state. Hence, there is a continuous
increase in the public expenditure.