Capital Market

Context: Economic Survey 2024-25 highlights concerns about the rapid growth of financial markets in India, emphasising that excessive financialisation can harm the economy. 

Relevance of the Topic: Prelims: Savings Trends in Indian Economy; Basic idea about Financialisation of Economy. 

What is Financialisation?

• Financialisation of Economy refers to the increasing dominance of financial markets, financial institutions, and financial motives in the overall economy.
  • It means that economic growth and wealth generation rely more on financial activities (like stock markets, banking, and investment funds) rather than traditional sectors like manufacturing, agriculture, or services.
• Financialisation of Savings refers to the shift of household or corporate savings from traditional, physical assets (like gold, real estate, or cash) to financial assets (like stocks, mutual funds, bonds, and insurance).

Aspects of Financialisation

• Expansion of Financial Markets:
  • Financial markets include the stock market, bond markets, derivatives, and foreign exchange markets.
  • Financial assets and instruments are increasingly traded on a global scale, driving economic growth, but also introducing volatility.
• Rise of Financial Institutions:
  • Banks, investment firms, hedge funds, and insurance companies have grown in power and influence over other sectors, including manufacturing and service industries. 
• Shift in Corporate Focus: Companies increasingly rely on stock buybacks, dividends, and mergers and acquisitions to boost stock prices, rather than reinvesting profits into productive activities. 
• Households and Financialisation:
  • Ordinary households have become more engaged in financial activities, from mortgage lending and credit card debt to retirement savings managed through pension funds and mutual funds.
  • Financial markets directly influence household wealth and savings, making them vulnerable to market fluctuations.

Implications of Financialisation

• Economic Inequality:
  • Benefits of financialisation tend to be concentrated among the wealthy, particularly those with significant financial assets, leading to rising income and wealth inequality.
  • Workers and middle-class households often do not benefit proportionately from financial growth.
• Vulnerability to Financial Crises:
  • Financialisation has made economies more vulnerable to financial shocks, such as the 2008 global financial crisis. 
  • The increasing complexity of financial instruments (E.g., derivatives, mortgage-backed securities) can lead to instability.
  • The interconnectedness of global financial systems means that a crisis in one market or country can have ripple effects worldwide. 
• Short-Termism:
  • Corporations and investors focus on short-term profits and immediate financial returns, often at the expense of long-term investment in innovation, infrastructure, and human capital. This short-termism undermines sustainable economic growth.
• Debt-driven Growth:
  • Financialisation often leads to a growing reliance on debt, both for governments and individuals. 
  • Consumer credit, corporate debt, and public debt have surged globally as access to credit has expanded.
  • This debt-driven growth can lead to bubble in real estate and other asset markets, increasing the risk of financial crises.
• Political Influence:
  • Financial lobbyists often shape policy in ways that favour the financial sector, such as deregulation and tax incentives.

Financialisation in India

• Widening role of financial markets: In India, financialisation is evident in the increasing role of financial markets, particularly with the growth of stock markets, insurance, and the mutual funds industry. 
• Rise in Retail Investors:
  • There has been a significant increase in individual investors participating in the stock market, both directly and through mutual funds.
  • The number of demat accounts (necessary for trading stocks) grew from 114.5 million in FY23 to 151.4 million in FY24.

Potential Risks:

• Risk of Overconfidence: Overconfidence might lead to speculative behavior, expecting higher returns that may not align with actual market conditions.
• Engagement of youth: Many new investors are young and may have a higher risk appetite, leading them to engage in derivatives trading, which is often speculative.
• Derivatives Trading Concerns:
  • Derivatives are financial instruments used for hedging but are often used for speculation.
  • Globally, most retail investors lose money in derivatives trading.
  • A significant market downturn could result in substantial losses for these investors, potentially discouraging them from future participation.

Lessons from other Economies:

• The Economic Survey warns that rapid financial market growth without corresponding economic growth has led to crises in both developed and developing countries.
• The 2008 global financial crisis is cited as an example of the dangers of excessive financialisation.

Recommendations:

• India should ensure a gradual and orderly development of its financial markets.
• All stakeholders, including investors, regulators, and the government, should work together to ensure that capital markets effectively channel savings into productive investments.
• Continuous financial education is essential to inform investors about the risks associated with speculative trading.