By reading this article you can solve the Model Question:
“The increasing dominance of domestic household savings in Indian capital markets has created stability but also new systemic risks.” Discuss.
GS-3 (TOPIC–ECONOMY)
Why in the News
- Recently, a significant transformation in India’s capital markets was highlighted, characterised by the replacement of Foreign Institutional Money with Domestic Household Savings.
- This shift, while enhancing market stability, exposes new retail investors to uneven participation and higher risks, prompting a focus on fixing asymmetry and strengthening investor protection for achieving inclusive growth towards “Viksit Bharat 2047.”
Background and Context: The Rise of Domestic Money
A structural change in market ownership is presently under way, with domestic savers becoming the market’s anchor. This shift is reflected in several key indicators:
- Foreign Institutional Ownership Decline: Foreign Portfolio Investor (FPI) ownership in Indian equities has reached a 15-month low of 16.9%, and 24.1\% in the NIFTY 50.
- Domestic Ownership Surge:
- Domestic Mutual Funds (MFs) are registering new highs quarter after quarter.
- Systematic Investment Plans (SIPs) are attracting record inflows.
- Individual investors, through direct holdings and MFs, now possess nearly of the market, the highest level in over two decades.
This increased domestic presence is helping reduce market volatility and provides institutions with a “flight-to-stability” option, exemplified by the NIFTY 50’s surge.
Macroeconomic and Policy Implications
The shift in market power has provided the Reserve Bank of India (RBI) with greater policy flexibility:
- Reduced Reliance on FPIs: Less reliance on FPI flows frees the RBI from the imperative of defending the rupee against capital flight.
- Prioritisation of Domestic Goals: Central bank can now prioritise stimulating bank credit growth and managing the growth-inflation trade-off.
- Inflation Control: This policy space is bolstered by record-low inflation, with CPI inflation easing to 0.3% year-on-year in October.
- Risk to Policy Space: Policy flexibility is not guaranteed; it could rapidly diminish if household confidence falters or if market downturns disproportionately impact vulnerable investors.
Growth in Primary Markets and Underlying Realities
Confidence in domestic capital is reflected in the boom in the primary market:
- Capital Mobilisation: Seventy-one mainboard listings in the current fiscal year have successfully raised over ₹1 lakh crore.
- Capital Formation Appetite: Announced investments by Indian companies exceeded ₹32 lakh crore in the first nine months of FY25, marking a 39% increase over the same period last year.
- Increased Private Participation: Share of private participation in these investment announcements has risen to around 70%.
However, this growth narrative is complicatedby underlying concerns
- Market Exuberance and Risk: Companies like Lenskart, Mamaearth, and Nykaa have commanded sky-high price-to-earnings multiples, raising concerns about market exuberance outpacing fundamentals and exposing retail investors to excessive risk.
- Performance Problem: The “performance problem” suggests most active fund managers struggle to consistently beat the market after accounting for risk and fees.
- Quality of Financial Advice: Celebration of MF and retail participation often overlooks the issue of quality of financial advice and the manner of wealth distribution.
Consequences of Unequal Outcomes and Structural Inefficiency
The structural inefficiency in the market system impacts the equitable distribution of wealth:
- Concentration of New Wealth: New equity wealth is observed to be concentrated among upper-income groups, especially in areas with formal financial access.
- Accelerated Wealth Inequality: Market stability built on such concentration may inadvertently accelerate wealth inequality.
- Household Wealth Decline: A recent decline in household equity wealth by ₹2.6 lakh crore in the last quarter is concerning, particularly if losses are concentrated among new, vulnerable investors.
- Dampened Aggregate Demand: High wealth concentration often results in a lower marginal propensity to consume, which can dampen aggregate demand.
- Damage to Long-term Trust: Market corrections, though normal, can damage long-term trust in markets if losses are concentrated among inexperienced investors without appropriate safeguards and education.
Challenges and Issues in India’s Savings Shift
The boom in domestic participation and primary markets conceals several structural inefficiencies and risks that must be addressed:
Investor Risk and Market Exuberance
- Retail Investor Preparedness: Millions of new retail investors are stepping in, and not all are prepared for market complexities.
- Exposure to Excessive Risk: Companies like Lenskart, Mamaearth, and Nykaa have commanded sky-high price-to-earnings multiples, raising concerns about market exuberance outpacing fundamentals and exposing retail investors to disproportionate risk.
- Quality of Financial Advice: The focus on participation often overlooks the issue of quality of financial advice.
- Damage to Long-term Trust: When losses are concentrated among inexperienced investors without appropriate safeguards and education, long-term trust in markets can be damaged.
Performance and Access Asymmetry
- “Performance Problem”: Financial literature highlights that most active fund managers struggle to consistently beat the market after accounting for risk and fees.
- Access Asymmetry Problem: The current financial system must confront the issue of unequal access and outcomes, shifting focus beyond mere information disclosure.
- Passive Fund Underutilisation: Active schemes hold 9% of the market while low-cost passive funds hold only 1%, indicating a reliance on higher-cost options that may underperform.
Wealth Distribution and Inequality
- Concentration of New Wealth: New equity wealth is observed to be concentrated among upper-income groups, particularly in areas with formal financial access.
- Accelerated Wealth Inequality: Market stability built on such concentration may inadvertently accelerate wealth inequality.
- Household Wealth Decline: A recent decline in household equity wealth by ₹2.6 lakh crore in the last quarter is concerning, especially if losses are concentrated among new, vulnerable investors.
- Dampened Aggregate Demand: High wealth concentration often results in a lower marginal propensity to consume, which can dampen aggregate demand.
Macroeconomic and Governance Risks
- Policy Space Instability: Policy flexibility enjoyed by the RBI could rapidly diminish if household confidence falters or if market downturns disproportionately impact vulnerable investors.
- Corporate Governance Concerns: As promoter holdings in the NIFTY 50 reach a 23-year low of 40%, it must be ensured that this reflects healthy capital raising, not opportunistic disinvestment.
Way Forward
- Expense ratios should be incentivised downward and promotion of passive, low-cost investment vehicles should be prioritised to reduce fee drag on retail returns.
- Financial literacy programs and quality advisory standards should be strengthened so that new retail entrants are better prepared for market volatility and risk management.
- Corporate governance and transparency norms should be fortified so that promoter stake reductions reflect healthy capital raising rather than opportunistic exits, thereby protecting long-term domestic savers.
- Regulatory oversight over primary market valuations and disclosure standards should be enhanced to reduce possibility of mispricing and safeguard retail investors.
- Data-driven interventions using gender- and location-specific data should be adopted to identify access gaps and design targeted inclusion measures for underrepresented groups.
- Monitoring mechanisms for household equity wealth distribution should be institutionalised so that market corrections can be managed without disproportionate harm to vulnerable investors and so that trust in markets is preserved.
Conclusion
- While the market’s new foundation built upon domestic savings offers promising stability, the promise of inclusive growth remains contingent upon resolving the access asymmetry and performance problem.
- Systemic safeguards, improved financial education, and robust corporate governance are indispensable for ensuring that the democratisation of markets does not become a source of future instability or wealth concentration among the privileged few.
