comparative study capital market of Indonesia, Malaysia, Turkey, Nigeria & Bangladesh

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Comparative Evaluation of stability of the stock markets and the factors contributing to stability or instability in these markets in the allotted counties to the respective groups


Prepared by
Kartikey Jain, Ashu Garg, Aayush Sood, Rohan Tigadi, Naseeruddin Ahmed
Semester VIII
Business Law Honours
National Law University, Jodhpur

Submitted to
Rituparna Das
Faculty, Financial Management Regulatory System





MALAYSIA
INTRODUCTION
Overall confidence and stability in the Malaysian financial sector has been preserved throughout the period of the global financial crisis, underpinned by a strong financial sector and negligible exposure to subprime-related assets and affected counterparties. Ample liquidity in the financial system also mitigated the risk of systemic contagion, thus allowing the financial sector to continue providing financial intermediation and services to the economy at large. Successful reforms of the financial sector following the Asian financial crisis have further reinforced the strong fundamentals supporting a sound financial sector in Malaysia.
As a highly open economy, Malaysia was, however, not insulated from the global economic downturn. The deterioration in global economic conditions and the major correction in commodity prices in the second half of 2008 saw Malaysia's GDP moderate to 0.1% in the final quarter of 2008. The domestic economy experienced the full impact of the global recession in the first quarter of 2009, declining by 6.2%. The concerted and pre-emptive measures taken by the Bank Negara Malaysia (BNM), through the accelerated implementation of fiscal stimulus measures, supported by the easing of monetary policy and the introduction of comprehensive measures to sustain access to financing and mitigate any impact of the heightened risk aversion among banks contributed towards stabilising the domestic economy in the second quarter and its subsequent recovery in the second half of the year. The economy resumed its growth momentum in the fourth quarter, growing by 4.4%. This resulted in the economy contracting by only 1.7% in 2009. Continued expansion in domestic demand and increased external demand led to the strong growth of 10.1% in the first quarter of 2010.
The causality relationship between economic growth and financial development is a controversial issue. Basically, the debate has been centered on whether it is the financial development that leads the economic growth or vice versa1. This "financial development economic growth puzzle" is complicated by another view that the relationship is dynamic in nature. To date, there is no-clear cut solution in which policy-makers could rely upon. We find that related researches done in the past three decades mostly focused on the role of financial development in stimulating economic growth, without taking into account of the stock market development.
It is particularly true that in the emerging economies, the evolution of stock market has great impact on the operation of banking institutions (Levine and Zervos, 1998; Khan and Senhadji, 2000). Thus, domestic stock market development is expected to have significant relationship the economic growth. The principle objective of this study is thus to re- examine the "financial development-economic growth puzzle" from the perspective of stock market development. The newly developed autoregressive distributed lag (ARDL) bounds test and the Granger Causality (GC) test based on vector error correction model (VECM) are employed to investigate the co-integration and causality relationships between stock market development and economic growth in Malaysia – a small and open emerging economy.

The stock exchange of malaysia
The stock exchange of Malaysia was established in year 1964 with an agreement of currency interchangeability between Malaysia and Singapore but later on in year 1976 both are divided into Kuala Lumpur stock exchange and stock exchange of Singapore and on April 14, 2004 it has changed his name to Bursa Malaysia Berhard. The Headquarter of Bursa Malaysia is located in the capital city of Malaysia, Kuala Lumpur. Now, Bursa Malaysia is an exchange holding company which is approved under the section 15 of the capital markets and services act 2007. Today the Bursa Malaysia is one of the largest bourses in Asia listing 1000 companies' worldwide. "To be the preferred partner in Asia for fund raising, trading and investment" is the vision of Bursa Malaysia (Bursa Malaysia, 2010).

Measure of Activity
FTSE Bursa Malaysia index is the index to measure the activity of Bursa Malaysia. FTSE group and Bursa Malaysia joined together in year 2006 on 26 June and they launched a FTSE Bursa Malaysia index series. FTSE Bursa Malaysia index helpful to the investors it allows them to do cross border analyses and a comparison to the management of the index series. The FTSE Bursa Malaysia index series includes seven benchmark indices like FTSE Bursa Malaysia KLCI, FTSE Bursa Malaysia mid 70 index, FTSE Bursa Malaysia top 100 index, FTSE Bursa Malaysia small cap index, FTSE Bursa Malaysia fledgling index and FTSE Bursa Malaysia EMAS index and it helps all stock sizes within the market.

Trends
FTSE Bursa Malaysia shows an upward trend with in last five years except in year 2009 it goes down just because of economic recession otherwise the stock market of Malaysia performed very well in last few years and after the recession this market improves a lot. In year 2005, the stock price was near about 900 and this price jumps to above 100 in year 2007 and the highest stock price goes till now is in year 2008 which is 1500 or more but after this the market goes down very badly and it comes to near about 850 but after this the stock market goes up and it reached to 1350 in till now.

History of stock market of Malaysia
The Bursa Malaysia is one of the important members of the global stock markets. In 1960, a Malaysian stock exchange market has been established and in this market both Malaysia and Singapore traded under a currency interchangeable agreement. In 1973 the exchange split into Kuala Lumpur stock exchange board and stock exchange of Singapore. The KLSEB has been renamed the Kuala Lumpur stock exchange. Again in 2004 the KLSE was renamed to Bursa Malaysia Berhard. In year 2007 the Bursa Malaysia had a market capitalization of US$189 billion and in the same year the main index had a market capitalization of US$ 307 billion which is called as Kuala Lumpur composite index (KLCI). It has divide the listed companies according to his size and growth like the high growth companies listed in the MESDAQ market, the large size companies listed in the Bursa Malaysia securities main board and the medium size companies listed in second board (Smith, 2007).

Factors contribution to stability or instability of Malaysian Stock Market (Bursa Malaysia)
In general, the Malaysian banking system entered the current global financial and economic crisis of 2007 from a much stronger position compared to the Asian financial crisis. The consolidation and restructuring of the banking industry together with improvements in the governance structure, risk management framework, infrastructure and practices, as well as the capacity building undertaken as part of the banking sector reforms following the Asian financial crisis, have significantly strengthened the foundations for financial stability.
Moreover, the Malaysian banking system operates within a diversified financial system, with a developed capital market. Total bonds outstanding accounted for 86% of GDP, providing an alternative funding source for the economy. The funding sources for businesses are evenly balanced between the equity and bond markets and the banking sector, thus diversifying credit risk concentration away from the banking system, which in turn provides the banking system with added capacity to withstand stress and shocks.
Another factor which prevented excessive risk-taking was the "originate and hold" business model adopted by banking institutions in Malaysia, where credit risks are retained within institutions' balance sheets. This served to align incentives with prudent risk-taking and ensured that lending institutions continued to vigilantly assess the repayment capacity of borrowers and monitor the quality of the loan throughout its tenure. The increase in the risk weight of non-performing housing loans to 100% since March 2005 under the regulatory capital framework further strengthened incentives for banks to maintain high-quality loan portfolios. The legal requirement for all foreign institutions in Malaysia to be locally incorporated, with capital committed to support Malaysian operations and obligations, also limited any contagion effects of stresses faced by foreign-domiciled parent banks located in the countries severely affected by the crisis.
These combined conditions enabled the banking sector to continue performing its financial intermediary role. As at end-September 2009, outstanding loans were growing at an annual rate of 7.2%, with a loan approval rate of 71.6%. In particular, outstanding loans to businesses remained stable, amounting to USD 85.9 billion as at end-September 2009, while outstanding loans to households continued to record steady growth. This was also supported by the lower cost of financing following the 150 basis point (bp) reduction in the overnight policy rate (OPR), which helped to sustain the demand for credit. With consumer confidence improving towards the second half of 2009, the purchase of big ticket items such as cars rebounded as more consumers took advantage of the lower cost of financing and the introduction of newer car models.
Given the high degree of interconnectedness between the Malaysian and the global financial system, Malaysia acted swiftly to implement pre-emptive and precautionary measures to preserve the stability of the financial system and ensure the continuity of credit flows. This included specific and targeted measures to preserve confidence and address the highly vulnerable segments and potential areas of stress:
extending a blanket guarantee on all ringgit and foreign currency deposits with commercial, Islamic and investment banks and deposit-taking development financial institutions regulated by the BNM through the Malaysia Deposit Insurance Corporation. The guarantee is in force until December 2010 and extends to all domestic and foreign banking institutions operating in Malaysia;
extending access to the BNM's liquidity facility to insurance companies and takaful operators regulated and supervised by the BNM;
ensuring banks' accessibility to USD liquidity for trade financing purposes; and
intensifying engagement with industry players, businesses and large corporate as well as trade bodies.
Efforts were mainly targeted towards ensuring that businesses and households continued to have adequate and uninterrupted access to financing.

Deepening capital market activity
The development of the Malaysian capital markets was one of the key strategic priorities during the 1990s and its importance was further emphasised in the aftermath of the Asian financial crisis, especially the importance of diversifying financing sources for the Malaysian economy. Led by a broad range of initiatives and policies implemented over the last decade, Malaysian capital markets have expanded considerably since the Asian financial crisis. The ringgit bond market is now the third largest in Asia, with total bonds outstanding at 86% of GDP. The focus on Islamic finance has seen Malaysia emerge as the leading market for sukuk issuances (more than 60% of global sukuk outstanding) with a market share of 45% of total global issuances recorded for the period January–September 2009. The corporate bond market has assumed a significantly more prominent role as an alternative source of financing for the corporate sector, accounting for a quarter of total financing as at end-2008 (1997: 10%). To further enhance access to capital market financing, Malaysia established its first financial guarantee institution, Danajamin Berhad, in 2009 to provide credit enhancements to viable corporations and businesses.

Conclusion
One possible explanation for why stock prices predict the economy is that stock prices actually cause what happens to the economy. This would be consistent with the wealth effect. According to this argument, fluctuations in stock prices raise and lower wealth, which in turn, raises and lowers aggregate consumption. As a result, economic activity is affected or "caused" by fluctuations in the stock market. Another possible explanation for why stock prices "Granger cause" economic activity is that the stock market is forward-looking. If investors are truly forward-looking, then stock prices reflect expectations about future economic activity. If a recession is anticipated, for example, then stock prices reflect this by decreasing in value. Since the results indicate that the stock market improves the prediction of economic activity, and if we assume that the stock market is forward-looking, then investors' expectations about the future economy are fairly accurate. Furthermore, since the economy does not predict stock prices, expectations about the future economy are not being formed by simple looking at past values of GDP, which is suggested by the adaptive expectations model. For the adaptive expectations model to hold true, past values of GDP would have to 'granger cause' stock prices.
In order to promote the stock market, there was several suggestions to be discuss as following: (1) Government could be liberalized stock market regulation towards the foreign direct investment (FDI) involve in the domestic equity market. By doing so, it was help to attract greater volume of FDI flow into Malaysia and providing portfolio diversification and enabling individual firms to engage in specialized production with efficiency gain. (2) Malaysia government has to develop the domestic equity market as there were evidences showed that a more developed equity market may provide liquidity that lowers the cost of the foreign capital essential for development, thus, nation with greater development of equity market tends to generate more domestic savings for economic growth. For example, in order to boost the confidence of foreigner to invest in Malaysia, we have to make sure that all public information which provided by all those public listed companies must be accurate and transparent. For recently cases of Transmile Group Bhd and Megan Media Bhd as its provided faulty company statement to the public, securities commission of Malaysia has been tighten the regulation such as Capital Markets and Services Act 2007 (CMSA) to avoid this scenario exist again. Hence, this was best to protect the interest of public by creating a fair and transparent condition for domestic equity market to rebuild the confident of foreigner as well as domestic investors. Besides that, more developed stock market does provide incentive for managers to make investment decisions that may affect firm value in the long run. (3) Lastly, government has to improve the liquidity of stock market by providing more capital market services such as derivative markets, thus, it enable firms to acquire much needed capital quickly to facilitate capital allocation for greater investment and lastly lead to economic growth. Those markets provided a platform for foreign portfolio investors as well as domestic portfolio investors to diversify their portfolio in domestic equity market.

NIGERIA
Introduction
The Nigerian financial market including the stock market, due to external and internal influences went into a downhill drop and led to the banking crisis of 2009. However, the economy has continued to grow rapidly, achieving over 7 percent growth each year since 2009. The performance of financial institutions has begun to improve, though some of the emergency anti-crisis measures continue to be in place. The success in maintaining financial stability after the crisis, and in the face of major external threats, reflects the decisive and broad-based policy response by the government and the Central Bank of Nigeria. Substantial liquidity was injected; a blanket guarantee for depositors, as well as for interbank and foreign credit lines of banks, was provided; the Asset Management Company of Nigeria (AMCON) was established to purchase banks' nonperforming loans (NPLs) in exchange for zero coupon bonds and inject funds to bring capital to zero; regulations and supervision were strengthened and corporate governance enhanced; and the universal banking model was abandoned and banks instructed to establish holding companies or divest their nonbank activities. The financial system continues to suffer from weak governance, including some non-transparent ownership structures, deficiencies in financial reporting, and endemic perceptions of corruption. These weaknesses were highlighted by failures and severe undercapitalization of several banks, contributing to banking sector consolidation from 89 banks in 2005 to 20 in 2012. The federal government's fight against corruption has resulted in an improvement in perception of the extent of corruption as indicated, for instance, by Transparency International in 2011. However, corruption continues to be a significant problem, including in the court system and other public authorities. The development and regulation of non-bank financial institutions require further reforms. The insurance sector needs better enforcement of compulsory insurance; improvements in product disclosure standards; and resolution of small unprofitable companies. The 2004 pension sector reform was helpful, but coverage remains low. Legacy funds' assets are yet to be transferred to Pension Fund Administrators. Although the Nigerian Securities and Exchange Commission (SEC) has made progress, more reforms are needed to further enhance oversight of the capital markets. The SEC has been without a Board since June 2012, jeopardizing its proper governance and functioning. Access to finance is an important constraint to Nigeria's development. There is negligible intermediation to small and medium-sized enterprises (SMEs) by the formal financial sector. While the microfinance sector has undergone significant changes, it remains characterized by numerous small, financially weak and ineffective institutions. In sum, the Nigerian economy has emerged from the banking crisis, and has the potential to enjoy an extended period of strong economic growth. This will be facilitated by a comprehensive strategy to exit from the crisis management period; to enhance protection against existing and emerging vulnerabilities; and foster financial deepening that can underpin sustainable growth for the periods ahead.

Capital Markets: Challenges and Issues
Capital markets remain relatively small, with low investor confidence since the crisis, and large sectors of the economy underrepresented. The only securities exchange operating in Nigeria is the Nigerian Stock Exchange (NSE). Its market capitalization dropped from US$80.6 billion (30 percent of GDP) at end-2008 to a low point of US$27.7 billion, before recovering to US$52 billion (12 percent of GDP) at the end of September 2012. At the end September 2012, there were 202 listed companies, of which only six new companies have listed since end–2009. The top five companies account for about 60 percent and the largest company over 25 percent, of market capitalization. Equity trading is dominated by foreign investors. Despite a large number of broker-dealers in the Nigerian securities market, the sector is concentrated. The 10 largest dealing members had over 75 percent market share during the first half of 2012. The collective investment scheme sector remains small. As at September 7, 2012, the Net Asset Value of the funds under management remained at approximately US$600 million, managed in only 43 collective investment schemes that were primarily open-ended unit trusts.

Nigeria (% of GDP)
Kenya
South Africa
Government Bonds
11.1
23.0
30.6
Non-government Bonds
1.4
2.8
27.0
Equities
16.7
30.3
2.1

The Nigerian Securities and Exchange Commission (SEC) has made marked progress since the 2002 FSAP, and has a number of significant achievements. Under the Investment and Securities Act 2007 (ISA), the SEC is the sole regulator of the securities markets. Since the adoption of the ISA, it has continued to strengthen and expand its rules and regulations. There are comprehensive legal provisions to ensure its robust governance structure. However, the SEC has been without a Board since June 2012. The authorities need to expeditiously finalize Board appointments. Further, corruption continues to be a significant problem in the Nigerian court system, although the government's efforts to combat it are gaining international recognition. SEC management is pursuing a zero tolerance policy against corruption, although internal and external reports suggest that the issue is not yet fully resolved. Additional reforms are needed. The SEC's independence needs to be further enhanced. Its mandate to issue rules and regulations is subject to the final approval of theminister of finance, who can also exempt a person from the application of the ISA. Even though the Senate does not have any formal role vis-à-vis the day-to-day operations of the SEC, in practice its views seem to have an impact on the SEC's decisions. This compromises the SEC's independence. The SEC should formalize its procedures. The regulatory framework is weak in prudential and organizational requirements, including internal control, risk management, and capital requirements. Broker-dealers have been rarely inspected, and the few inspections conducted have been reactive, triggered by major deficiencies in capital. The limited supervision of broker-dealers can potentially introduce systemic risk through the securities settlement system. In addition, the SEC should exercise its comprehensive enforcement powers in a timely, effective, and consistent manner.
Stress Tests
Stress tests suggest that most Nigerian banks could withstand extreme shocks. The tests, which were carried out in close cooperation with the CBN included three macroeconomic scenarios, which were translated into single and multi-factor shocks: i) a slowdown in the global economy and a sharp drop in oil prices; ii) continuing terrorist attacks in the North; iii) economic deterioration elsewhere in Africa; and (iv) a decline in value of the AMCON bonds and increased contingent fiscal liabilities of the government. These tests suggest that a severe increase in overall NPLs would result in undercapitalization of just a few banks. The general resilience reflects banks' high capitalization and currently low NPLs,10 which in turn reflects the banking system restructuring and recapitalization after the 2009 banking crisis. However, some individual banking institutions appear vulnerable, and one is insolvent even before any stress test. The credit risks analysis suggests that the highest risk comes from credit concentration to single names and group borrowers. 26. Stress tests were not derived from econometric time series analysis (so called macro stress tests) because of lack of structural breaks. The banking sector time series (including that for the NPLs) have recent and fundamental structural breaks due to the major consolidation since 2005–06, and the significant changes in the structures of the banks' balance sheets following their surrender of bad assets. Among these effects was the reduction of NPLs from about 35 to about 5 percent in 2011. The analysis demonstrates that in the event of a default of one bank, there would be only one small systemically unimportant bank defaulting through interbank linkages. The interbank market appears clustered with most banks being either lenders or borrowers, and contagion risk through interbank exposures is generally small (Figure 4). In general, the interbank market is capable of withstanding significant adverse liquidity and funding shocks.
Major Developmental Issues for the capital markets
1. Access to bank credit for SMEs is very low. Nigeria lags significantly behind comparator countries, with access to finance described as the biggest obstacle to development after the lack of a reliable supply of electricity.
2. Banks and SMEs lack capacity and suffer institutional deficiencies, holding back higher credit growth in the sector.
3. The microfinance sector has undergone significant changes and continues to be in a state of transition. The 2005 Microfinance Policy Framework, revised in 2011, provided the basis for the emergence of the microfinance sector. The government is pursuing a financial inclusion agenda with highly ambitious targets, but at the moment lacks an implementation strategy. Licensing requirements could usefully be reviewed.
4. There are five active Development Finance Institutions (DFIs), but their financial state is precarious, preventing them from meeting their mandates. The DFIs specialize in agriculture, housing, the SME sector, export-imports, and infrastructure. However, the financing gaps that they are established to address are not well defined, and often their mandate deviates from the targeted market failure.
5. The CBN administers nine Development Finance Schemes (DFSs) aimed at addressing diverse agendas in development finance. These schemes combine lines of credits and guarantees. The majority are aimed toward a developmental objective, although some have been used to bail out or restructure troubled sectors (as in the case of the recently constituted airline scheme). All represent a contingent liability to the FMoF. Given their mixed performance and the contingent liability they represent, the FMoF should review their appropriateness, design and performance. Bailout related activities should not be financed by the CBN.
6. Housing finance remains underdeveloped. Mortgage loans outstanding represent just 0.36 percent of Nigeria's 2011 GDP, while the estimated housing shortfall is thought to be as much as 16 million units. The gap between production and demand is growing as Nigeria urbanizes and the population increases. Primary Mortgage Institutions (PMIs) have been unable to deliver the finance necessary to allow for the required investment into the housing sector. The CBN's new regulatory framework for PMIs, raising minimum capital to 5 billion, should help rationalize the sector. Standardization of the mortgage underwriting process and documentation would create a more efficient system and prepare lenders for a secondary mortgage market.

TURKEY
Introduction
Turkey's liberal financial markets have been facing serious destabilising effects of financial globalization. Turkey's experience with liberalization, deregulation and open financial markets have been disappointing. The most painful and explosive experience has taken place in the public sector deficits and indebtedness. This paper tries to discuss more serious sources of financial instability in the framework of the theory of the fiscal crises of the state, specifically, the theory of "bifurcation of monetary and real accumulation" and the consequent "socialization of debts". It reaches to the conclusion that financial flows were delinked and severed from real accumulation and real economic activities; private saving surpluses were shouldered by the public deficit. Turkey has "emerging" financial markets. The process of liberalization and deregulation began in 1980. Since mid-1989 Turkey is a financially open economy with a fully convertible currency. In terms of capital flows, it is far more open many European countries. Financial liberalization and financial deepening have not resulted in a significant internalization of the markets or in providing useful net transfer of funds. Yet, Turkey's liberal financial markets have been facing serious destabilising effects of financial globalization. The general characteristics of Turkey's financial markets are extreme volatility and fragility.

Liberalization and Deregulation in Turkey
The timing and the process of liberalization and opening up of foreign trade and capital markets started after Turkey fell into foreign debt payment problems in the late 1970's. The stabilization program began to be implemented under the International Monetary Fund conditionality. Foreign trade was liberalized basically in the early 1980's, and further in the process of joining the customs union with the European Union in 1996. Financial deregulation began in 1981 when controls on interest rates were removed. In 1984 foreign exchange trade was liberalized. In 1986 Istanbul Stock Exchange was reopened. In 1987 the central bank began open market operations. The benchmark date for financial liberalisation is 1989 when controls on capital movements were removed and Turkish currency became convertible. After this date Turkey became a financially open economy. Below, we analyze the extend of foreign capital flows to Turkey and the share of capital flows in total domestic financial markets. We will concentrate on the period of 1987-1997, since it is a period during which trade liberalization and financial openness proceeded well.
A. Trade Openness and Current Account Balance
Trade liberalization resulted almost no increase in the importance of exports of goods Its share to the GDP was stuck around 12-13 percent. Rather, exports of services have risen and import of good and services has surged tremendously. The share of imports to the GDP rose from around 15 percent to 30 percent. Trade openness increased continuously. as the share of foreign trade to the GDP rose from 25-30 percent to around 55 percent. Trade openness resulted in higher dependency on imports. Trade account deficit deteriorated continuously which jumped by almost three times, from around 4 percent to 11 percent of the GDP. However, .as trade account deficit was deteriorating, service incomes were growing. Thus, during this period Turkey did not face seriously high current account deficit
B. Current Account Balance and Foreign Capital Flows
Table (1) shows current account balance and foreign capital flows to Turkey as ratios to the GDP. Table (1) shows net inflows and outflows of foreign capital. The volume showed an increasing trend. Thus net flows as a percent of the GDP has an increasing tendency. This is expected, since the correlation between liberalization and capital mobility generally is high.
In the early1990's there were important amounts of capital inflows, mostly in short-term capital. However, Turkey experienced net outflows of capital in 1988, 1991 and 1994. In 1995-1997, capital inflows were higher than those in the previous inflow periods, reaching 5 percent of the GDP. Again, short-term movements were more important. The composition of capital flows changed over the period. Foreign direct investment was very disappointing in volume and in its ratio to the GDP. It was never higher than around half a percentage point. In addition, its paak was juust before capital account liberalization in 1989. Net portfolio investments were positive along these years. Their ratio to the GDP was relatively higher only in 1992 and 1993. There is no systematic information about the type of portfolio flows going into debt securities or shares. Foreign capital flows to and from Istanbul Securities Exchange were ridden with fluctuations. There were surges in 1988-9, 1992-93. Declines or reversals were severe in 1990, 1991, 1994 and 1996. In recent years, the most important flows were in short term capital. Short term credit use and changes in the reserves and asset holdings of commercial banks were determinants of these flows. The movement of funds between commercial banks and the central bank related to reserve positions influenced net short-term capital movements. This results in the inclusion of transactions between domestic entities. Thus, balance of payment statistics does no longer represent transactions between foreigners and nationals. Turkey was a net payer of short-term credit in 1988, 1991 and 1994 in which years Turkey experienced financial crisis. In 1987-1995, Turkey was a net payer of medium and long term credit, except in 1987 and 1993. Only in 1996 and 1997 net flows took place, mainly as a result of some tax exemptions of firms and commercial banks for borrowing for longer maturity than one year. In 1997, borrowing was switched from short term to medium term. In total, foreign capital flows did not provide significant and dependable amount of funds; they proceeded literally by bursts and busts; also, a systematic degree of diversification in capital flows could not be observed. Turkey experienced foreign capital inflow surge in 1990 when capital account liberalization was in effect. The Gulf Crisis put a very serious break on this. In 1992-1993 there was another surge which was interrupted and reversed by 1994 financial and following real crises. In 1996-1997 there was an even higher inflow mainly in the form of short-term capital movements. These were again interrupted and reversed by 1998 word-wide crises. As the importance of portfolio investment and short-term loans increased, Turkey faced with the types of capital inflows that could be reversed abruptly. As a matter of fact, both types of capital showed similar patterns in inflows and outflows.

We should evaluate foreign capital flows in relation with the current account balance. The current account balance shows an erratic pattern. During the period it was in deficit in seven years, in surplus in four years. When in deficit, it was quite small, around 1.5-2 percent of the GDP. Nevertheless, last two years it was showing increases, climbing to around 3 percent. These levels were not indicating a serious balance of payments problem. However, beneath this appearance, certain signs indicate that the relationship between current account balance, foreign capital movements and the real side of the economy were becoming apart and delinked. We will concentrate on three areas of connection: Errors and omissions; actual and optimal current account positions; and reserve movements. One of the characteristics of current account statistics is that the "net errors and omissions" item which shows unrecorded transactions has become so important as to change the current account balance very considerably. This is obviously the result of the deregulation of capital movements that makes difficult to capture all transactions. As a matter of fact, net errors and omissions are accepted as short-term capital movements as called "hot money" that moves for speculative purposes. A comparison of actual and optimal current account balance positions could be served to establish the relationship between current account balance and the real side of the economy represented by optimal current account. Actual and optimal current account balance positions for the Turkish economy was tested by a study (Akcay and Ozler 1998:44-45). This study used a model that does quite well in capturing the current account shifts of a large number of developed as well as less developed countries. The application of this model showed large divergences between actual and optimal current account balance positions. The actual current account balance was found to be larger than the optimal current account balance. Since there was almost no capital account restrictions, the deviations could not be interpreted as an indication of imperfect capital mobility. The writers came to the conclusion that the higher variance of the current account movements after 1989 could be interpreted as an indication of the presence of speculative capital movements, and not restrictions of capital flows. Thus, the relationship between current account balance and the real side of the economy became apart and delinked. In addition, the relationship between current account
C. External Capital Flows and Internal Capital During the period, the ratio of investment to the GNP did not change much whereas the ratio of total bank credits increased by 20 percent, that of portfolio assts by three times. Even if foreign capital flows may seem small relative to the GDP, their volume may be important relative to internal real and financial investments. However, in the case of Turkey this was not true for foreign direct investments and portfolio investments. Table (2) shows the share of foreign capital flows in total investment and financial assets. Foreign direct investment was never higher than 2.79 percent of total investments, and relatively higher shares were observed in the first years of financial liberalization. Later, it had a declining trend, falling to around percent in 1997. Capital account liberalization failed to attract real investment funds. Foreign portfolio investments in relative terms fluctuated considerably. They were important relative to the total in 1988, 1989, 1992 and 1993. Then they fell especially as short-term credits increased. In 1997, their relative share was no larger than that was in 1987. However, what is important, as their share fluctuated, they caused serious instabilities in financial markets. Considering that an important part of foreign portfolio investment appear to go in treasury bills and bonds, the fluctuations affect directly budget financing. As we will analyse below, the pattern of financing budget deficits and their relation with the monetary side of the economy has bifurcated severely from the real side of the economy. Thus, at least some part of foreign portfolio investments contributed to the delinking.

As mentioned earlier, systematic information is not avaiable on the foreign share in the stockmarket. A recent comprehensive study by Gunes and Saltoglu on the Istanbul Stock Exchange states that, due to data insufficiency, the issue of foreign investment on stocks could not be analysed (Gunes and Saltoglu 1998:121). The total volume increased from 1.5 percent to the to around 30 percent during the period. The study analysed econometrically the movements of stock earnings and sources of extreme volatility. It found that the movements of earning rates could not be explained by any macroeconomic and financial factors, meaning that earning movements were determined outside the basic macroeconomic and financial relations; there were no macroeconomic and financial basis for earnings volatility. The stock exchange market was not related to other markets and the overall macroeconomic system. It operated in a speculative and manipulative manner. The volatility was related to daily transactions that were not in line with macroeconomic influences. Even if economic fundamentals and parameters did not change, the stock market experienced very high volatility. This volatility was determined essentially within the market itself and by speculation. (Gunes and Saltoglu 1998:64-67, 109, 121, 136). Thus, whatever the role foreign portfolio investments played in the stock market, the market itself is not related to the real economy, circulating significant amount of money for speculative and manipulative manners, absorbing resources from real accumulation, contributing only to financial instability. Financial volatility and instabilities are even much greater in credit markets. The ratios of foreign credit relative to the internal credit volumes were much bigger and erratic compared to other types of foreign capital flows. As explained above, short-term foreign credit flows are much more important. Also, Turkish credit supply is largely short-term. During the period, the volumes of these foreign flows were increasing and the ratios of inflows and outflows were getting bigger. Such leaps and bounces and busts reaching minus 29 percent and plus 24 percent within a period of only three years in 1994-1996, drove the economy extremely unstable. Any real economic foundations cannot possibly explain these movements. Thus, foreign credit flows relative to the determinants total credit extension in Turkey were severed. However, the effects of these erratic flows on growth rates of the economy were serious. As Table (2) shows, in every year that foreign credit outflows took place, growth rates were very low or negative.
Conclusion
In Turkey, financial liberalization since 1989 resulted mainly in currency substitution and public debt, private surpluses and public deficits. The relationship between savings and productive investments is delinked. The relationship between foreign and domestic borrowing for deficit financing and public service and public investment financing has been severed.

bangladesh
Introduction
The financial system is a set of institutional arrangement through financial surpluses in the economy are mobilized from surplus units and transferred to deficit spenders. Creating and supporting efficient financial systems should be a high priority in development. Much of the wealth of developing countries remains invested in traditional savings vehicles such as gold, land, or "cash under the mattress". But formal savings systems provide a more productive and often safer conduit for funds than these other alternatives. The formal financial system when efficient, well regulated, and competitive or at least contestable can offer lower intermediation costs than informal channels. The main constituents of any financial system are: financial institutions, financial instruments and financial markets.
Financial Institutions: The modern name of financial institution is financial intermediary, it mediates or stands between ultimate borrowers and ultimate lenders. Financial institutions are generally classified under two main heads: a) Banks and b) Non-Bank Financial Intermediaries. Financial intermediaries include banks (central bank, commercial banks, investment banks etc.), Securities and Exchange Commission (SEC), specialised financial institutions, development financial institutions and institutional investors (i.e. Investment Corporation of Bangladesh).
Financial Instruments: Financial Instrument is the financial claim of the holder against the issuer. Financial
Instruments are of two types: Primary or Direct and Secondary or Indirect Financial Instruments.
Primary or direct financial instruments are financial claims against real sector units.
Secondary or indirect financial instruments are financial claims against financial institutions or intermediaries.
Financial Markets: Financial market is the market where financial instruments are purchased and sold. The market can be classified into a number of ways, but from the duration point of view, it is classified into two: money market and capital market.
(1) Money market is a market where financial securities maturing in less than one year that is short-term fund are transacted. Typical money market instruments are certificates of deposits, treasury bills, post office savings etc.
(2) The Capital market is a market for long-term funds. It facilitates an efficient transfer of resources from savers to investors and becomes conduits for channeling investment funds from investors to borrowers. The capital market is required to meet at least two basic requirements: (a) it should support industrialization through savings mobilization, investment fund allocation and maturity transformation and (b) it must be safe and efficient in discharging the aforesaid function. It has two segments, namely, securities segments and non-securities segments.
Securities Segments - The securities segment is concerned with the process a firm distributes its securities to the public in the primary market and the securities are then traded in the secondary markets. Financial intermediaries, such as merchant banks, Asset Management Company, underwriters, broker-members etc. are involved in the process. Securities segments of capital market have two important roles to play:
(a) Information production and;
(b) Monitoring. Security segment of the markets can be divided into two:
(1) Primary or New Issue Market: The market in which newly issued securities are sold by their issuers, who received the proceeds. Securities are issued in the primary market by one or more of the following methods:
(a) Public Issue: An offer to the public by an issuer through a prospectus for subscription. This is the most common method of primary market placement in Bangladesh.
(b) Private Placement: An offer to specific known persons selected by the sponsors for procuring subscription.
(c) Right Issue: An offer in which existing shareholders are offered new securities in proportion to their existing holdings.
(d) Offer for Sale: An invitation to the general public to purchase the stock of a company through an intermediary.
(2) Secondary Market: Market that permits trading in outstanding issues; that is, stocks or bonds already sold to the public are traded between current and potential owners. The proceeds from a sale in the secondary market do not go to the issuing unit, but rather to the current owner of the security. Again secondary market has four parts:
(a) Organized Stock Exchange: Securities are traded according to organized rules and regulations.
(b) Over-the-counter (OTC) Market: OTC market includes trading in all stocks not listed on one of the exchanges. The OTC market is not a formal organization with membership requirements or a specific list of stocks deemed eligible for trading. In theory, any security can be traded on the OTC market as long as a registered is willing to make a market in the security (willing to buy and sell shares of the stocks). Generally companies which are unable and unwilling to enlist, float their shares in the OTC market.
(c) Third Market: The term third market describes over-the-counter trading of shares listed on an exchange.
(d) Fourth Market: The term fourth market describes direct trading of securities between two parties with no broker intermediary. In all most all cases, both parties involved are institutions.

Non-securities Segments - are those markets in which loan / equity loan are provided by the banks and financial institutions, such as Nationalized Commercial Banks (NCBs), Development Financial Institutions (DFIs), Private Commercial Banks (PCBs), Investment Corporation of Bangladesh (ICB). Broadly non-security segments are divided into two parts: (a) Banking Financial Institutions and (b) Non-Banking Financial Institutions. We need to recognize that conditions in the bank-based system are unpalatable in the sense of huge non-performing loans, high degree of classified and default loans, capital inadequacy of banks and the like.

Dhaka Stock Exchange
In the early part of 1952, about five years after the independence of erstwhile Pakistan in 1947, the East Pakistan Stock Exchange Association Ltd., an independent Stock Exchange, was incorporated on April 28, 1954. It changed name to the East Pakistan Stock Exchange Ltd. on June 23, 1962 and finally to its present name of the Dhaka Stock Exchange Ltd. on May 14, 1964. However, formal trading began in 1956 with 196 securities listed on the DSE with a total paid up capital of about Taka 4 billion. After 1971, the trading activities of the Stock Exchange remained suppressed until 1976 due to the liberation war and the economic policy pursued by the then government. The trading activities resumed in 1976 with only 9 companies listed, having a paid up capital of Taka 137.52 million on the stock exchange. The total numbers of securities listed with the DSE stood at 267 in March 2004 against 260 securities in June 2003. As of March 2004 the issued capital and debenture of listed securities amounted to Tk. 4723.30 crore as compared with the Tk. 3608.10 crore in June 2003 registering an increase of 30.91 percent. As of March 2004 the market capitalization of all securities stood at Tk. 10042.90 crore which was Tk. 7299.80 crore in June 2003 showing an increase of 37.58 percent the weighted average share price index in June 2003 was 823.14 against 973.88 March 2004 in June 2003.
The Dhaka Stock Exchange (DSE) is registered as a Public Limited Company and its activities are regulated by its Articles of Association and its own rules, regulations, and by-laws along with the Securities and Exchange Ordinance, 1969; the Companies Act, 1994; and the Securities and Exchange Commission Act, 1993 (DSE, 1999). As per the DSE Article 105B, its management is separated from the Council. The executive power of the DSE is vested with the Chief Executive Officer (CEO). The CEO is appointed by the Board with the approval of the SEC. Following graph shows the year wise price index of DSE.

Concept of Volatility
Volatility is the most basic statistical measure. It can be used to measure the market risk of a single instrument or an entire portfolio of instruments. While volatility can be expressed in different ways, statistically, volatility of a random variable is its standard deviation. In day-to-day practice, volatility is calculated for all sorts of random financial variables such as stock return, interest rate, the market value of portfolio, etc. stock return volatility measures the random variability of the stock returns. Simply put stock return volatility in the variation of the stock return in time. More specifically, it is the standard deviation of the daily stock return around the mean value and the stock market volatility in the return volatility of the aggregate market portfolio.

Components of Stock Market Volatility
Researchers have sought to analyze the relative importance of economy-wide factors, industry-specific factors, and firm-specific factors on a stock's volatility. This approach borrows from modern asset pricing theory and its emphasis on so-called factor models, or models that assume a firm's stock return is governed by factors such as the overall market return, the return on a portfolio of firms sampled from the same industry, or even changes in economic factors such as inflation, changes in oil prices, or growth in industrial production. If returns have a factor structure, then the return volatility will depend on the volatilities of those factors. Campbell, et al. (2001) assume the factors are the overall market return, an industry return (e.g., financial, industrial, etc.), and an idiosyncratic noise term that captures firm-specific information. They document the important empirical fact that while volatility moves considerably over time, there is not a distinct trend upwards or downwards. More interestingly, however, since 1962, there has been a steady decline in stock market volatility attributed to the overall market factor; that is, the common volatility shared across returns on different stocks has diminished over that period. The variation ascribed to firm-specific sources, by contrast, has risen. The implication for investors, then, is that they need to hold more stocks in their portfolios in order to achieve diversification.

Stock Market Volatility and Dividends
Stock market performance is usually measured by the percentage change in the stock price or index value, that is, the returns, over a set period of time. One commonly used measure of volatility is the standard deviation of returns, which measures the dispersion of returns from an average.
If the stock market is efficient, then the volatility of stock returns should be related to the volatility of the variables that affect asset prices. One candidate variable is dividends. But research conducted in the early 1980s suggests that variation in dividends alone cannot fully account for the variation in prices (see Le Roy and Porter 1981 and Shiller 1981). Prices are much more variable than are the changes in future dividends that should be capitalized into prices. Asset prices apparently tend to make long-lived swings away from their fundamental values. This fact turned out to be equivalent to the finding that, at long horizons, stock returns displayed predictability. Thus, the literature on excess volatility broached the possibility that the stock market may not be efficient.


In the excess volatility literature, it was seen that the dividends that are capitalized in the stock price arrive in the future and need to be "discounted" back to the present using a discount rate (Krainer 2002). In the early research it was assumed that this discount rate was constant. However, discount rates depend on investors' preferences for risk, which could very well change over time. Therefore, stock market volatility may not be excessive if discount rates are variable enough. Thus, the real contribution of the excess volatility literature was to call attention to the fact that corporate dividends are simply too smooth a series to account for the high volatility in prices. Subsequent research necessarily focused away from the payout policy of firms and toward the characteristics of investors and of actual stock market trading.

Indexes
In analyzing volatility of security markets of Bangladesh, this report is based on the analysis of indexes of two security markets of Bangladesh. Rather considering individual stock, the portfolio (all treaded stocks, Debentures and mutual funds) is considered. Each market calculates two indexes. DSE use General Price Index and DSE20. CSE use General Price Index and CSE30. DSE20 represents the top 20 stocks of DSE and CSE30 represents top 30. Both the bourses of the country introduced SEC prescribed index under weighted average method and excluded 'Z Group' shares from the calculation list since November 2001. Both the indices have replaced the conventional age-old all share price indices which had been as the benchmark barometer of the bourses. DSE named the new index as Weighted Average Share Price Index and the base index has been calculated at 817.62 points while the CSE calls the new index Trade Volume Weighted Index, which stood at 1836.72 points on the close of first day trading. SEC termed the new move as an attempt to arrest any bid to bring down or push share prices up by trading a small number of shares.

These security-market indexes have five major specific uses. These are,
To examine total returns for an aggregate market or some components of a market over a specified time period and use the rates of return computed as a benchmark to judge the performance of individual portfolios.
To develop an index portfolio. Index portfolio led to the creation of index funds to track the performance of the specified market series (index) over time.
To examine the factors that influence aggregate security price movement by securitises analysts, portfolio managers and others use security-market indexes.
To project future stock price movements, technicians would plot and analyze price and volume changes for a stock market series.
An individual risky asset is its systematic risk, which is the relationship between the rates of return for a risky asset and the rates of return for a market portfolio of risky asset. Therefore it is necessary when computing the systematic risk of an individual risky asset (security) to relate its return to the returns for an aggregate market index that is used as a proxy for the market portfolio of risky assets.

Persistence of Stock Market Volatility
Stock market volatility tends to be persistent; that is, periods of high volatility as well as low volatility tend to last for months. In particular, periods of high volatility tend to occur when stock prices are falling and during recessions. Stock market volatility also is positively related to volatility in economic variables, such as inflation, industrial production, and debt levels in the corporate sector (see Schwert 1989).
The persistence in volatility is not surprising: stock market volatility should depend on the overall health of the economy, and real economic variables themselves tend to display persistence. The persistence of stock market return volatility has two interesting implications. First, volatility is a proxy for investment risk. Persistence in volatility implies that the risk and return trade-off changes in a predictable way over the business cycle. Second, the persistence in volatility can be used to predict future economic variables. For example, Campbell, et al. (2001) show that stock market volatility helps to predict GDP growth.

INDONESIA
Introduction
The story that Asia is becoming the growth centre of the world economy is in circulation for some time. The dynamics of the world economy are changing. Stock market plays a vital role in the growth of key sectors of the economy and that ultimately affects the economy of the country. Stock market plays the significant role for the industry and also for the investor who wants to invest in the stock market to gain maximum return on his savings. This study identifies the factor affecting performance of stock market in Indonesia .Indonesia is the largest country in Southeast Asia, both in population and in area. In 1997-1998, Indonesia faced one of the most costly financial crises in recent history, as nearly its entire banking sector collapsed. This cost the government a staggering 50 percent of GDP – one of the highest fiscal costs paid so far by any country in history. The Indonesian financial markets have shown a remarkable recovery from the Asian Crisis in the late 1990s. Prudent fiscal management and strong economic fundamentals have succeeded in realizing robust growth in recent years. Future projections look even more promising with annual GDP growth of at least 6.0 percent in the coming years. The Indonesia Stock Exchange (BEI) Composite Index, which can be regarded as the main indicator of financial market performance, has been experiencing substantial growth since 1999 up until the present. The BEI index suffered a record low in 1998 amidst the crisis but reached a record high in 2013. In 2010 this BEI was the best performing index in the Asia Pacific region, increasing by 44 percent. Currently, Indonesia is well on track to receive investment grade status by international credit rating agencies. In late 2011 Fitch Ratings was the first of such agencies to reinstate Indonesia's investment grade credit rating status after a 14-year hiatus. In January 2012 Moody's Investors Service followed suit citing the country's resilient economy. It is assumed that these upgrades will trigger more capital inflows as a number of funds are limited to invest in investment grade economies only.
It will be important, however, that this robust expansion is accompanied by a deepening of Indonesia's capital markets. Currently, capital markets are smaller and less liquid in Indonesia than compared to other ASEAN countries and emerging economies. This is due to the low capital market utilization to finance investments and limited intermediation by non-bank financial institutions (modest hedging and insurance facilities). Securities and equity markets are relatively underdeveloped and market capitalization of Indonesia's listed companies is lower than that of its regional peers. On the positive side, it means that Indonesia has ample room for growth.
Importance of strong financial sector
A substantial body of research has established that financial sector development is critical for economic growth, and that the size of the banking sector, as well as the size and liquidity of the stock market, has been shown to be highly correlated with subsequent growth of gross domestic product (GDP) per capita. There is also evidence that financial sector development causes economic growth. Linkages between economic growth and poverty reduction are also well established, as are the linkages between financial sector development and poverty reduction. The significant adverse impacts on growth and poverty reduction caused by financial crises over the years, including the Global Financial Crisis in 2008-2009 and the ongoing crisis in Europe, further illustrate the importance of a well-functioning financial sector for the Indonesian economy.
Looking ahead, Indonesia will require a strong and stable financial sector to meet its future development goals. The government has set forth an ambitious plan for development and poverty reduction that requires a substantially more diversified and inclusive financial sector. In particular, in the recently articulated master plan for development, the Acceleration and Expansion of Indonesia Economic Development, 2011-25 (MP3EI), the government is aiming for a massive level of investment in the real economy of more than Rp4,000 trillion (about $414 billion at current exchange rates). In addition to potential external sources of financing, such a large investment can only come from a strong domestic financial sector – one that must be equipped and able to support such a huge level of investment.
Overview of Indonesian capital markets
Although there has been strong growth since the Asian financial crisis, Indonesia's capital markets remain small compared to the overall size of the financial sector, and also modest in terms of the country's GDP. For example, at only 10 percent of GDP, Indonesia has one of the smallest bond markets in the region, on a par with Vietnam. Equity markets have grown strongly in recent years, with stock market capitalization recently reaching 55 percent of GDP .However, much of this growth is driven by a handful of companies (the top 10 companies account for 41 percent of market capitalization), and there is limited mobilization of capital from the primary markets.
Indonesia's capital markets are currently not a major source of funding or a significant vehicle for long-term investment. Reluctance by some of the largest companies in Indonesia to publicly list severely limits the range of liquid instruments available for investment. Further development of the capital markets is needed to facilitate market-based price discovery for the fixed income securities market, to diversify and manage risk, and to provide investors with alternative investment opportunities. Development strategies focus attention on increasing the domestic investor base, while foreigners continue to play an important role in Indonesia's capital markets.
Importance of stock markets and challenges faced by Indonesian stock market
Stock market is important because whenever any company wants to raise funds and consider other than debt option they float their shares into the market and raise funds from the investors who keen to invest in that company the company list themselves in the stock market and issue their shares through IPO (Initial Public Offering) if the company is already listed in the stock market and want to raise fund by floating their shares they have two options available either they offer their shares to the market and anyone who is interested to invest in that company purchase their shares or they offer the right shares to the existing shareholders. There are some rules and regulations imposed by the regulators of stock markets which companies have to fulfill if they want to list in the stock market. The primary function of any stock market is to play the role of supporting the growth of the industry and economy of the country and it is also the measurement tool that gives the idea about the industrial growth as well as the stability of the economy with their performance. The rising index or consistent growth in the index is the sign of growing economy and if the index and stock prices are on the falling side or their fluctuations are on the higher side it gives the impression of un stability in the economy exist in that country. The movements in the stock prices are affected by changes in fundamentals of the economy and the expectations about future prospects of these fundamentals. Stock market index is a way of measuring the performance of a market over time. These indices used as a benchmark for the investors or fund managers who compare their return with the market return.

Stock market transaction costs in Indonesia tend to be higher than comparable markets in the region, acting as a further deterrent to market development. Certain withholding taxes also appear high; a number of countries keen on developing their markets have removed these. Although the Indonesian government has provided tax relief to companies that list their shares, this concession has not reduced reluctance among many companies to make their financial information public. One of the most important issues is the development of a deep and liquid domestic fixed-income market. The government fixed-income market is growing in liquidity, but the development of a corporate fixed-income market continues to lag. Over several years, the Ministry of Finance has made significant strides in creating benchmarks and extending the yield curve. The government is also considering the impact of its issuance strategy in crowding out corporate debt issuances. The main challenges in security market are:
Globally economic recession
Improvement of the security market, such as: Investor Protection Fund
Very small percentage of local investors
Few listed public companies
Misperception of investing in stock market islike a gamble & only for the rich people
Improvement of continuous settlement, Single Investor ID (SID) and Straight-Through-Processing (CTP).

The specific challenges in Indonesia Equity Market are:
The equality of comprehension of knowledge about investing in equity securities
Introducing the capital market activities to attract much more investors
Monitoring system of securities transaction to conform with the Capital Market Rules
Implementations of separate securities and cash account for each investor

Important Factors affecting (in)stability of Indonesian Stock Markets
Financial Liberalization and its Contribution to stock market integration
To a large extent, the goal of financial liberalization is to reduce the impediments to a free flow of capital and to encourage domestic investment. Indeed, a recent paper by Henry (2000), which carefully examines twelve developing countries with policy initiatives that opened their stock markets to foreign investors, found that these countries experienced significant growth in their levels of private investment. He also found that the stock markets of these liberalizing countries experienced positive abnormal returns during the eight months leading up to the implementation of their initial efforts to open their stock markets to foreign investors. Although Henry did not include Indonesia in his sample, an earlier paper by Roll (1995) found that Indonesian stock prices approximately doubled in December 1988 when restrictions on the foreign ownership of Indonesian stocks were lifted. In the latter half of 1980s and early years of 1990s, most of the governments of ASEAN have liberalized their stock markets. Stock market liberalization is a decision by a country's government to allow foreigners to purchase shares in the country's stock market. It gives a foreign investor the opportunity to invest in domestic equity securities and domestic investors the right to transact foreign equity securities.
For most emerging markets, liberalization is an essential policy tool that attracts much needed foreign capital for investment purposes. Financial literature has presented a strong emphasis on the integration of stock markets with the interest increased considerably following the abolition of foreign exchange controls, the introduction of innovative financial products, such as country funds and American Depository Receipts, which have created more opportunities for global international investments. Thus, this implies that financial liberalization has contributed to the stock markets integration.
Diversification
A well-diversified financial sector, with sound banks, capital markets as well as nonbank financial institutions (NBFIs), is key to supporting the government's articulated development objectives of increased economic growth, greater job creation and higher living standards. Banks, capital markets and NBFIs are key elements of a healthy and stable financial system, complementing each other and offering synergies. Well-developed capital markets and NBFIs can play a major role in achieving Indonesia's development goals and would enhance the stability of the country's financial system. Capital markets and NBFIs have the potential to unlock long-term domestic resources for investment in sectors critical to growth such as infrastructure, and increase access to low-cost financial services.
Indonesia's financial sector more than quadrupled in size in nominal terms from 2000 to 2011. This period was also accompanied by significant reforms in a number of areas in the financial sector. Despite this, the level of diversification in the sector is still very low, with the banks playing a highly dominant role to the exclusion of other players such as finance companies, pension funds, mutual funds and insurance companies, which together account for only 20 percent of the sector. Despite growth in the overall financial system, the relative shares of different types of institutions in the sector have hardly changed, and the basic structure of the sector remains much the same as in the wake of the 1997-1998 Asian crisis. The challenge going forward is to make it less bank-focused and more diversified. . In line with the priorities of the Indonesian government in moving towards a higher-income country status, strengthening capital markets and NBFIs is now an urgent policy imperative.
Top of Form
Bottom of Form
Effect of Monetary Policy
The objective of the monetary policy is to control and boost up the foreign investment through the stock market. An important monetary policy instrument used by Bank Indonesia is the Bank Indonesia (BI) Rate. This is the main instrument of Bank Indonesia in controlling macroeconomic and financial performance. The monetary policy instrument is significant in influencing the macroeconomic and financial stability. BI rate is Indonesia's monetary policy instrument used to control the monetary and financial sector. Mishkin and Eakins (2000) also discussed that the objectives of monetary policy is to achieve: (1) high employment, (2) economic growth, (3) price stability, (4) interest rate stability, (5) stability of financial markets, and (6) stability in foreign exchange markets. Empirical evidence confirmed that the central bank still faces many challenges in achieving the macroeconomic and the stock market stability. In order to control the positive and negative relationship among macroeconomic indicators and stock market index regarding the trade off, central bank should maintain the monetary instruments effectively.



It has been concluded that monetary policy is effective in achieving the monetary and macroeconomic objectives namely price stability, foreign exchange stability, economic growth and financial markets stability through each indicator. Findings are consistent that the monetary instruments have a significant effect in achieving the improvement particularly on stock market index. Bank Indonesia had utilized all the monetary instruments effectively through the monetary policy transmission mechanisms. The effectiveness of monetary instruments, that is Bank Indonesia rate and Money Market Rate, generates market expectations towards the credibility of policy makers. In addition, positive expectations of investors and firms toward the macroeconomic performance, which is represented by the inflation rate, exchange rate, and output growth affect the market behavior and improve the stock market performance.
Conclusion and recommendations
Notwithstanding that financial sector stability has been largely achieved and an initial and crucial set of financial sector reforms have been carried out, Indonesia's financial sector authorities are now faced with an even more challenging and far reaching policy agenda. It requires the nation to maintain its momentum and avoid resting on its recent success in passing safely through global financial turbulence. However, to ensure that Indonesia's financial sector proves a match for the continuing global financial volatility and also reforms its financial sector so that it can provide the massive support that the country needs to develop into a high-income nation in the next decade or two, a policy agenda is a requisite for continued success. The next level of reforms also requires coordination across agencies and involves bringing together and harnessing resources of a large number of partners. If financial sector reform continues to build on the success and stability achieved in the past decade in the ways discussed, and rises to the challenge that presents itself now, there is every chance that Indonesia can continue to move forward towards its goal of becoming a high-income country.
Indonesia's capital markets are limited in both scope and depth and are not a major source of funding or a significant vehicle for long-term investment. Further development of the capital markets is needed to diversify funding and investment opportunities and manage risk. Moving forward, although the challenges are quite significant, there are some steps that can be taken to further develop Indonesia's capital markets.
Investor confidence must be strengthened. Investor confidence can only improve if, among other things, any single market stakeholder or group of stakeholders cannot unduly influence the functioning of the markets. Augmenting the capital market law to provide Bapepam-LK with the necessary tools, including appropriate enforcement powers, is essential. Sanctions must be of sufficient magnitude to effectively deter violations. Legal and accounting standards, currently not perceived favorably, are critical components of market integrity.

The government's strategy should continue to assist in the development of a more diverse and liquid market. The government can encourage listing on the stock market of additional shares of SOEs to expand the current limited pool of instruments, privatize more SOEs, as well as encourage SOEs to raise long-term funding through the issuance of fixed income securities. The MOF has made significant strides in creating benchmarks and extending the yield curve, and should continue to ensure that its auctions do not crowd out corporate debt issuances.

Expand the institutional investor base by further promoting the insurance, pension and mutual fund industry. As Indonesia continues to grow, these institutions will play an increasingly important role and will require access to a variety of instruments of longer duration as well as tools to effectively hedge their risks (e.g., by increasing mandatory retirement savings as was done in Chile). The authorities could also review the cost of capital market transactions, including taxes, to determine if they are high compared to other markets. Although the government has provided tax relief to companies that list their shares (a 5 percent reduction for companies who float at least 40 percent of their shares), this concession has not overcome the reluctance of many companies to make their financial information public.

Greater independence and a full commitment to better cooperation among domestic and international authorities should be accelerated. As it merges with the new financial services authority, Bapepam-LK should focus additional efforts on improving and intensifying its oversight programs, develop cooperation arrangements in writing to assure information sharing in their joint oversight of regulated entities, and take steps to combat market abuses. The move towards accounting oversight and practices in line with international standards should be expedited.

Self-regulatory organizations could do more to promote educational programs, professional training, and the credibility of the capital markets as an attractive employment sector.

Encourage private corporations to use domestic capital markets for their financing needs by addressing some of these impediments. Currently, many of Indonesia's largest companies choose to raise capital either offshore or via retained earnings.