What is the importance of financial markets in an economy?

Financial markets match buyers and sellers or lenders to buyers at a given time and reflect the performance of the economy. Demand and supply are a function of the market. Businesses need capital to grow and to expand their respective business thus, where the financial market plays a critical role in the buildup of capital and the production of goods and services providing access to capital. In a well-developed and efficient market, the transaction costs are always lower with efficient transfer of funds; it can be mean also a lower cost of financing and a safe return on investment. In developing countries, which have limited financial market, the poor legal system, transparency may make it more costly to raise capital and may lower the return on savings or investments Vis a Vis the risk. A good financial market helps in the creation of wealth and provides a link between savings and investment that meet the short-term and long-term financial needs of both the household and corporate sector through efficient mobilization and allocation of surplus.

Macroeconomic factors mentioned such as growth, inflation, business cycles, etc have a strong impact on the financial markets. Financial structures fund businesses and companies, contributing to job growth and, in turn, growing economic development and trade. Increased trade leads to increased competition, such as sales and marketing that increase jobs in these sectors further. Whether it is primary, secondary and tertiary sectors all need capital for growth, and the need for capital is balanced by the financial system.

Security is a right on the issuer’s future income/profits or assets. Usually, financial markets are characterized by transparent pricing, simple trading rules, costs and fees, and market forces that decide the prices of securities that sell.

Financial markets affect the opinion of the public and provide an outline of the economic landscape. A continuous rise in stock exchanges such as Nifty/BSE gives confidence to the businesses. In such scenarios, businesses hire more employees, decreasing unemployment and in turn producing more disposable income to the common people. In the case of the diminishing market, or in the event of market crashes, business becomes worried about their financing, making layoffs, and panic in the economic ecosystem.

Capital markets and institutions such as banks play a key role in the economy by controlling risks and allocating savings to productive activities, facilitating economic development, and enhancing overall welfare while running smoothly. The right mixture of the well-developed financial market and the variety of capital products and resources available better fits the requirements of investors, as well as those who are seeking capital and who has, have excess capital. Thus fueling the engine of the economy or simply capital formation. A sound economy can exist only when there is a well-developed market.

The Indian financial market has developed and is bigger now after liberalizing policies in 1991 and is different from what it used to be back in the 1980s.

An efficient financial market can serve the following purposes:

• Supporting investors managing their capital for different time horizons with financial products.
• It provides a source of capital for businesses depending on short-term or long-term financing requirements for both private as well as the government.
• Minimizing risks by some strategies such as hedging or diversification.
•  Act as a mirror reflecting the economic conditions of the country/states.

Confidence booster for attracting capital through foreign inflows or investments.

Provides access to information to market participants enabling taking precautionary measures.

The financial market has become a source of judging point on how global or national economies are performing in today’s scenario. The effect of government economic policies such as fiscal, monetary can be easily observed on stock and bond exchange markets. The volume of trades in stocks and bonds reflects the performance of the businesses as well as the sovereign. For example, when RBI takes the decision to increase/decrease interest rate, the effect can be easily observed on the bond/equity market.

Financial markets are used by developed economies to maintain their economic and social stability and increase their economic level. Dormant or developing economies look at financial markets to finance its BOP (balance of payments) accelerating its development agenda for social and economic stability. For new economies or developing economies the growth of the financial market depends on the reforms taken by the government, also reforms should be in such a way that it should match the frequency of local or international level investor's requirements. Thus, they give considerable importance to the growth and development of the financial sector to achieve their agent of employment generation and poverty reduction.