Are Indian markets liquid?

Let us first understand the liquidity and the efficiency aspect of the Indian Financial Markets. When we look at liquidity (the ability to transact at low costs), there are three aspects to it Immediacy, Depth and Resilience. Immediacy as in ability to trade without moving the prices, depth as in the amount that can be traded without taking shocks, and resilience as in speed to recovery after a large shock. When we look at the current market scenario only large cap stocks and futures and index futures meet these three criteria of liquidity. Among other markets only government bonds and interest rate swaps to an extent are liquid. On the other hand there is no market for corporate bonds, commercial papers and commodity futures.
This lack of liquidity in the market translates into low efficiency. This is due to the high interconnectedness of the two concepts. Efficiency relates to how quickly and to what extent are information and forecast priced in. For markets to be efficient, the investors need to have an incentive to share the information, and for them to have an incentive the markets should be liquid, otherwise their profits will vanish due to high transaction costs.

Are more markets and liberalization the answer?
The two biggest reasons for the lack of liquidity as mentioned in the Raghuram Rajan Report are “Banning of products and markets” and having “Rules that impede participation of firms and individuals in certain markets for reasons other than sophistication”. The banning of markets is an obvious cause of illiquidity. Furthermore the absence of one market might lead to illiquidity and inefficiencies in other markets as well. The argument around some markets being manipulated does not have much meat, as a market becomes efficient and thus less prone to manipulation only when there is broad participation. Thus adding more markets would not only improve the liquidity but also add to the efficiency of the financial markets.
The other key reason involving restricted participation is also hampering the liquidity of the markets. Accessibility is a key element in improving the liquidity of the markets. Currently only equities and derivatives markets are accessible to all kinds of participants. Otherwise markets like Government Bonds, Credit Derivatives, Commodity Futures and Options are fairly restricted. Especially interesting to note is the debt market where government’s share in the public debt is a mindboggling 91%. This is much higher than the world average of 47% or even China’s share at 68%. We need to take a cue from the most unrestricted market i.e. equities which has achieved high liquidity and efficiency. As a result of liberalization in terms of who all are allowed to participate, the equity market reaches global investors, and hence no investor becomes large enough to distort the prices, leading to high efficiency levels.