New Delhi: While saying that the surge in retail investors in India’s stock and derivatives markets is “hugely welcome”, the Economic Survey 2023-24 also voiced a strong note of caution, saying that “the possibility of overconfidence” and speculation is a serious concern.
The survey, tabled in Parliament Monday by Finance Minister Nirmala Sitharaman and written by Chief Economic Advisor V. Anantha Nageswaran and his team, also said that a significant correction in the stock markets carries much higher risks for those investing in derivatives.
Such a shock, it said, could dissuade investors from returning to the stock markets for a long time, which would be a loss not only to them but also to the economy. Further, it pointed out that a significantly overvalued stock market “is a harbinger of market instability rather than market resilience”.
The report noted that historically, developing countries face “debilitating” crises when growth in the financial markets outpaces real economic growth.
A need for ‘careful consideration’
“While the outlook for India’s financial sector appears bright, some areas will require focused attention going forward,” the survey said. “The significant increase in retail investors in the stock market calls for careful consideration.”
“This is crucial because possibility of overconfidence leading to speculation and the expectation of even greater returns, which might not align with the real market conditions, is a serious concern,” it added.
The document pointed out that over the last few years, India’s capital markets have seen a surge in activity by retail traders investing directly and indirectly through mutual funds.
It pointed out that individual investors’ share in the equity cash segment turnover was at 35.9 percent at the end of FY24, while the number of demat accounts — mandatory to trade on the stock markets — rose from 11.45 crore in FY23 to 15.14 crore in FY24.
“The enhanced participation of retail investors in the Indian capital market is hugely welcome and lends stability to the capital market,” the survey said. “It has also enabled retail investors to earn higher returns on their savings.”
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Excessive valuations ‘harbinger of market instability’
However, it also pointed out that excessive valuations, not pegged to the real economy, come with their own dangers.
While it noted that India’s market capitalisation to GDP ratio has significantly grown over the last five years, from 77 percent in FY19 to 124 percent in FY24 — “far higher” than that of other emerging market economies such as China and Brazil, it said it was “essential to strike a note of caution”.
“The market capitalisation to GDP ratio is not necessarily a sign of economic advancement or sophistication,” the survey noted. “Financial assets are claims on real goods and services. If equity market claims on the real economy are excessively high, it is a harbinger of market instability rather than market resilience.”
ThePrint last week reported that India’s market capitalisation to GDP ratio was now even higher, at 140 percent, and several other metrics, along with insights from market analysts, pointed to the formation of a stock market bubble.
The survey further highlighted the surge in India’s derivatives trade, saying that such trading activity has the potential for “outsized gains” and caters to “humans’ gambling instincts”, even as they serve to augment income, if profitable.
“These considerations are likely driving active retail participation in derivatives trading,” it said. “However, globally, derivatives trading loses money for the investors, for the most part.”
A 2023 paper by the markets regulator — Securities and Exchange Board of India (SEBI) — found that 9 out of 10 retail investors in the derivatives segment in India lost their money.
“Raising investor awareness and continuous financial education is essential to warn them of the low or negative expected returns from derivatives trading,” the survey said.
“A significant stock correction could see losses, which are more considerable for retail investors participating in capital markets through derivatives,” it further warned. “Investors’ behavioural response would be to feel ‘cheated’ by unseen, more considerable forces. They may not return to capital markets for a long time. That is a loss to them and the economy.”
‘Financialisation’ hasn’t worked globally
Overall, it said the “financialisation” of economies has not ended well, even for developed economies, giving the 2008 global financial crisis as an example. It added that developing countries face “debilitating crises” when financial market “innovations” and growth “run ahead of economic growth”.
“The Asian crisis of 1997-98 set back the high-flying economies of the region for a long time,” it said. “Therefore, India needs to have an orderly and gradual evolution of the financial market.”
To move towards this, it said, all stakeholders, including market participants, market infrastructure institutions, regulators, and the government, must ensure that capital markets play their “theoretically assigned role” of channelling savings to their most productive investments.
“It is not just in the national interest. It is an act of self-interest, too,” the survey said.
(Edited by Madhurita Goswami)
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