Basics about primary and secondary stock markets

Quite a few of you have asked me at one time or the other to define or explain about stock markets. More specifically primary and secondary markets. You can’t get a better explanation than the one that appeared in today’s article ‘Not so primary a market’ in the ET.

For the impatient amongst you, the following excerpt would be just enough:

For sustained economic growth, it is essential to have a stock market that mobilises and allocates capital efficiently. To place the capital market in perspective, it would be useful to distinguish between the “new issues market” and “stock exchange”. The “new issues market” allocates long-term funds to corporates in an economy without constraining the investment horizon of the investors. The “stock exchange” facilitates buyers and sellers to transact in securities issued in the “new issues market”. Hence, the economic significance of the stock market stems from its role as an allocator of resources. As a result, the “new issues market” which is of primary importance to the economy is called the primary market and the “stock exchange” which provides liquidity and facilitates price discovery is called the secondary market.

A vibrant secondary market must ensure an efficient primary market. However, in the case of India, though the economy is home to the third and the fifth largest exchanges in the world in terms of the number of transactions, the amount of capital mobilised in the primary market is negligible. To substantiate this claim, it may be noted that between 1996 and 2006 debt instruments accounted for more than 80% of the funds raised from the primary market. Dependence on debt per se is not bad, however, what makes the situation grim is the fact that more than 80% of the debt was issued in the form of private placement.

In terms of mobilising funds from the capital surplus economic units, the primary market attracts less than 4% of the total savings of the household sector.