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stock market and the Banks promote economic growth and it provides a critique of their functions in transitional economies. Every country depends on its economy for its growth. For a country to be stable it has to be stable in terms of its economy. Bank and stock market contribute to a great extent to the economy growth of every country where it provides firms with opportunity to get funds thus encouraging more investment from the firms. At the same time they give information on the ways resources should be allocated. The development of a financially sound, market-oriented banking system is always considered to be fundamental to a flourishing transition. Arguably, it is important to macroeconomic stability and to positive long-term growth prospects. As documented, bank intermediation in transition economies continues to be stunted after a decade or addition of reform, mainly where advancement in banking reforms is inadequate. The banking system profitability still stands to be unimpressive, after the effect of inflation on valid profitability is taken into account.
When we consider the balance between return and risk provided by the stock markets in transition economies, the developing countries and industrialized market economies have provided a higher favorable balance between risk and return during the earlier four years than the transition economies as a group. The price-to-book-value ratios are lesser in the transition group as compared to developing countries. It is obvious that firms that are flourishing in investing their capital together with their borrowings will likely to have sturdy prospects for earning growth and will get a reduced discount rates used in their future earnings.
Considering the modern economy, banks and stock markets represent a key component of the financial system. Even though they may execute dissimilar functions in the economic development process, their distinctiveness is barely emphasized within the framework of economic growth. The analysis by King and Levine (1993) cannot differentiate between the functions of stock markets and banks. As per the physical accumulation, banks and stock markets offer sources of external financing for firms. In terms of the role of resource allocation, stock markets and banks generate information to direct the allocation of resources. They vary only by means of transmitting information. Stock markets information is enclosed in equity prices, while loan managers collect that in banks.
Dow and Gorton (1995) conveyed a model analysis that if the major function of the stock market is to signal information for monitoring, evaluation and financing, banks may be similarly efficient at proficient resource allocation. Even though some papers had analyzed the effect of stock market on social welfare (Bresnahrah, Milgrom, and Paul (1992), has connected empirically stock markets and economic growth on volume or investment productivity.
Another perception on the connection involving financial development and economic growth is based on savings, investments, financial markets and growth. The analysis is that financial markets will increase savings, investment and hence the growth rates. The stock market is considered to promote savings by offering households with an extra instrument which may meet their liquidity need and risk preferences. Considering the well-developed capital market, share ownership gives individuals with a fairly liquid ways of sharing risk in investment projects. There is also substantial proof on the level to which these markets are playing a function in distributing capital to the corporate sector and the useful effects for the rest of the economy. Though the structure of corporate finance differs broadly between the developing countries, the corporate sector used equity finance which is significant.
Share of net investment expenditures, equity funds became more than debt finance, or internally generated funds in 1980s within the countries like Korea, and Thailand (Singh and Hamid 1993). This was extremely different with the corporate finance pattern in industrial countries, which in broadly depended heavily on funds generated internally. The evidence shows that the stock market is not performing this savings role at all well. Thus, more current research on the functions of the stock market in an economy has stressed on the function of a developed stock market, which boost the effectiveness of investment, in turn leading to higher economic growth. Consequently, stock markets can improve economic growth by investment productivity as compare to savings function.
Stock market liquidity and banking development predict growth, productivity improvement and capital accumulation, when entered collectively in regressions, even after controlling political and economic factors. The consequences are constant with the opinion that financial markets offer significant services for growth, whereas stock markets offer different services from banks. Stock market size, integration and volatility, with world markets are never robustly connected with growth, and that no financial indicator is very much associated with private saving rates. Substantial debate exists on the relationships involving economic growth and the financial system. Historically, economists have concentrated on banks. Walter Bagehot (1873) and Joseph Schumpeter (1912) put emphasis on the critical significance of the banking system in economic growth and underscore conditions when banks can actively spur innovation and future growth by determining and funding productive investments.
In contrast, Robert E. Lucas (1988) highlights that economists put a lot of emphasis on the function of the financial system, and Joan Robinson (1952) analyze that banks respond passively to economic growth. Empirically, Robert G. King and Ross Levine (1993a) indicate that the extend of financial intermediation is a fine predictor of long-run rates of economic growth, productivity improvements and capital accumulation. There is an increasing theoretical literature on the relations between stock markets and long-run growth, with very diminutive empirical evidence. Levine (1991) and Ross M. Starr (1995) base their models where additional liquid stock markets (markets where it is not so much expensive in trading equities ) decrease the disincentives to investing projects which takes long time since investors can easily sell their stake in the project if they want their savings before the project matures. Improved liquidity, hence, facilitates investment in higher-return projects on long-on that boost productivity growth. Similarly, Michael B. Devereux and W. Smith (1994) and Maurice Obstfeld (1994) indicate that higher international risk which is shared through internationally integrated stock markets bring on a portfolio shift from safe, low-return investments to high-return investments, thus speeding up productivity growth.
These risk models and liquidity, nevertheless, also mean that international capital market integration and higher liquidity vaguely influence saving rates. Better risk-sharing and higher return may influence saving rates to come down such that general growth slows with additional liquid and internationally integrated financial markets. Furthermore, theoretical debate exists about whether greater stock market liquidity supports a shift to higher-return projects that motivate productivity growth. Given that additional liquidity formulate it to be easier to sell shares, a number of them argue that more liquidity decrease the incentives of shareholders to carry out the expensive role of monitoring managers (Andrei Shleifer and Robert W. Vishny 1986; and Amar Bhide 1993). In turn, corporate governance which is weak impedes effective slow productivity growth and resource allotment. Thus, theoretical debate continues over the relation involving economic growth and the functioning of stock markets.
Stock market liquidity as measured by the value of trading relative to the size of the economy and the value of stock trading relative to the size of the market is significantly and absolutely correlated with the present and future rates of economic growth, productivity growth and capital accumulation. Stock market liquidity tends to be a robust predictor of physical capital, real per capital GDP growth and productivity growth once controlling for fiscal policy, openness to trade, initial income, and initial investment in education, political stability, macroeconomic stability, and the forward looking nature of stock prices. Besides, the banking development level as measured by loans from the bank for the private enterprises divided by GDP too enters significantly to these regressions.
Stock market liquidity and banking development are good predictors of economic growth. The additional stock market indicators do not possess a robust link with long-run growth. Volatility is unimportantly connected with growth in the majority of specifications. Likewise, international integration and market size are never robustly related with growth, and none of the financial indicators is strongly linked to private saving rates. The outcome have proposition for a diversity of theoretical models. The strong, positive links involving stock market liquidity and capital accumulation confirm productivity improvements and faster rates of growth, Levine's (1991) and Starr's (1995) theoretical predictions.
Banks offer different services compared to those of stock markets. Banking development and stock market liquidity measures enter significantly to the growth regression. Stock market liquidity and banking development are positively and strongly connected with present and future rates of economic growth even once controlling for various other factors related with economic growth. Stock market liquidity and banking development foretell long-term growth. Though this investigation does not establish the direction of causality between financial sector development and growth, the results show that the strong link between financial development and growth does not just reveal contemporaneous shocks to both, that stock market and banking development do not merely follow economic growth, and…[continue]
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