Role of Financial Markets in Economic Growth

As the financial markets play an essential role in the economic growth of a country, businesses and industries lead to these financial systems in order to boom their economic activities and domestic trade. Financial intermediaries help in improving the investment efficiency of a country, leading to a higher economic growth.

As the GDP of a country increases, the standard of living of the people of the country also develops, meaning overall economic development. Demand and Supply are the main functions of the economy.

Let’s look at the role the Financial Markets play in the Economic Growth of a country.

Role of Financial Markets in Growth of an Economy

The following are the several roles played by financial markets in booming economic development of a country.

Growing Capital Markets

As every business requires capital to fund their business activities and production, they usually require 2 types of capital, which are, Working & Fixed Capital. While fixed capital is used for investment in fixed assets such as plant and machinery, working capital is raised for day-to-day running of operations in the business such as purchase of raw materials.

The financial markets enable the exporters and importers to receive and raise funds in order to settle transactions. It also enables banks to borrow and lend customers in various foreign currencies. This is an advantage for the government as well as it helps in meeting their foreign exchange requirements through the functioning of capital market.

Trade Development

As the financial markets support both domestic and foreign trade, it helps in providing discounts over financial instruments such as treasury bills and commercial papers. Foreign trade also develops through pre-shipment and post-shipment finance by commercial banks and a Letter of Credit is issued in favor of importers.

The financial market helps in easy exchange of documents between the buyer and seller through banks as the buyer does not need to meet the seller for negotiation. Such fast transactions in trading helps in the development of economy.

Relationship between Savings & Investment

The financial markets facilitate direct flow of savings and investments in the country. Banks play a major role in allowing the depositors to invest money in FD’s and RD’s by offering them attractive rates of interest.

Such savings are channelized by the banks to provide credit to different business institutions involved in production and distribution. Banks also enable resource allocation across several sectors in the economy.

Government Securities

Financial markets help the government in raising funds by letting them borrow at a lower rate of interest. The federal and local governments are allowed to raise short-term as well as long-term funds from the government securities market in order to fund capital requirements by issuing bonds and bills.

The government can also borrow money from the money market through treasury bills as they offer attractive rate of interest. Therefore, to develop the trade, industries and commerce within the country, the money, capital and foreign markets play a huge role ensuring economic development.

Balanced Growth of Economy

Once all the sectors begin to grow simultaneously, it will create a balanced growth in the economic development. As the financial markets facilitates savings into investment channels helping mobilization and efficient use of funds by allowing investments in several sectors of the economy.

The financial markets play an important role in channelizing these funds and productively using them by distributing them to each sector in a manner that it maintains the balance in the growth of the industries, agriculture, service sector and the whole economy of the country.

Foreign Exchange Markets

The foreign exchange market enables exporters and importers to receive and raise funds in order to settle the transactions. It also helps in borrowing money from banks in order to provide funds to several customers in different foreign currencies such as Pounds, Dollars or the Euro as per their requirement.

Foreign exchange markets also give banks an opportunity to invest their short-term idle funds to earn profits and helps the government to meet their foreign exchange requirements through this market.

Growth of Financial Infrastructure

The financial infrastructure has a strong financial bearing over the growth of the economy. It signifies the financial assets, the financial market and the financial intermediaries as the three main pillars in the growth of economy.

Provision of funds for the growth of infrastructure and industry facilitates through financial services. As the financial market provides the mechanism for trading financial assets through these financial intermediaries, they act as a link between the savers and the investors to successfully transfer the resources among them.

Growing Employment Opportunities

As the financial system grows, it generates more and more job openings within the economy. As the financial markets provide funds for businesses, it results in the increase of production, requiring more man power. It increases the employment growth for both, the organized and unorganized sector.

As the industrial and business operations increase rapidly, the employment opportunities open for more sectors such as sales, marketing, advertising and so on. Startups help create more employment.

Ensures Political Stability

The political conditions of countries with a developed financial system and markets will always be stable. Countries such as India and Pakistan, suffering from unstable political conditions on an every day basis will not only face injustice in their financial system but also in their economic development as a whole.

Control through Fiscal Discipline

Thanks to the financial markets, the governments are able to create congenial business atmosphere where neither inflation nor depression is experienced. The industries should be given proper protection through the financial markets in order to fulfil their credit requirements even in difficult phases.

The government can raise adequate resources in order to meet the financial requirements to avoid hampering the economic growth. It also regulates the market through proper legislation to avoid speculative transaction and to minimize the use of black money, maintaining fiscal discipline while controlling the whole economy.

Conclusion

For any new or developing economy, financial markets play a huge important role in the growth and development of the economy to other to meet the frequency of local or international level investor’s requirements. Therefore, focusing on growing the financial markets will directly impact the development of the economy big time.