Economic Survey: Govt admits ballooning market cap not a reflection of robust economic health

The Economic Survey 2023-24 tabled on Monday (July 22) has spotlighted an issue often overlooked in the euphoria of booming stock markets: high market capitalisation relative to GDP.

While soaring stock values are frequently heralded as indicators of economic prosperity, the Union government has cautioned that this is not always a sign of economic strength.

An excessively high market capitalisation compared to the goods and services produced can be a harbinger of market instability.

Note of caution

“It is essential to strike a note of caution. The market capitalisation to GDP ratio is not necessarily a sign of economic advancement or sophistication. 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,” the 2023-24 Economic Survey pointed out.

It further said that while derivatives are hedging instruments, investors worldwide mainly use them as speculative instruments, and India is likely no exception.

“Derivatives trading holds the potential for outsized gains. Thus, it caters to humans' gambling instincts and can augment income if profitable,” it said.

Barometer of economic health

Market capitalisation, the total value of a company’s outstanding shares, is often used as a barometer of economic health.

A rising market cap is generally perceived as a positive signal, suggesting robust corporate performance and investor confidence. However, when this figure grows disproportionately compared to the GDP — the total monetary value of all goods and services produced within a country — it can create a misleading picture of economic vitality.

The Economic Survey points out that India’s market capitalisation to GDP ratio has significantly increased, reaching 124 per cent in FY24 from 77 per cent in FY19.

This surge places India well ahead of other emerging markets like China and Brazil. On the surface, this seems like a testament to India’s economic prowess. But the reality, as the Survey highlights, is more nuanced and warrants a cautious interpretation.

Surge in retail activity

The survey, authored by Chief Economic Adviser V Anantha Nageshwaran, said the Indian capital markets have seen a surge in retail activity through direct (trading in markets through their accounts) and indirect (through mutual funds) channels in the last few years.

The individual investor's share in the equity cash segment turnover was 35.9 per cent in FY24. The number of demat accounts with both depositories rose from 1,145 lakh in FY23 to 1,514 lakh in FY24.

The impact of this influx of individual investors in the market is also reflected in new investor registrations with the exchanges, their share in total traded value, net investments, and ownership in the listed companies.

Retail participation

For instance, the registered investor base at the National Stock Exchange (NSE) nearly tripled from March 2020 to March 2024 to 9.2 crore as of 31 March 2024, potentially translating into 20 per cent of Indian households now channelling their household savings into financial markets.

A rise in retail participation was more substantial and steadier through the indirect channel, via mutual funds. FY24 has been a spectacular year for MFs, as their AUM (assets under management) increased by ₹14 lakh-crore (35 per cent year-on-year growth) to ₹53.4 lakh-crore at the end of FY24, boosted by mark-to-market (MTM) gains and the expansion of the industry.

The MF segment currently has about 8.4 crore systematic investment plan (SIP) accounts through which investors regularly invest in schemes. Annual net SIP flows have doubled in the last three years, from ₹0.96 lakh-crore in FY21 to ₹2 lakh-crore in FY24. Total SIP AUM is approximately 35 per cent of the AUM of the MF industry for equity-oriented schemes.

Mutual fund ownership

This has increased ownership of MFs in Indian equities to 9.2 per cent as of 31 December 2023, compared to 7.7 per cent as of 31 December 2021.

The number of unique tax IDs registered on the NSE rose from 2.7 crore in FY19 to 9.2 crore in FY24.

The enhanced participation of retail investors in the Indian capital market is hugely welcome and lends stability to the capital market. It has also enabled retail investors to earn higher returns on their savings.

Most new retail investors are likely young and may have a higher risk appetite. It is also reflected in the interest that retail investors have shown in derivatives trading, especially expiration-day trading.

Derivatives trading

While derivatives are hedging instruments, investors worldwide mainly use them as speculative instruments, and India is likely no exception.

Derivatives trading holds the potential for outsized gains. Thus, it caters to humans' gambling instincts and can augment income if profitable. These considerations are likely driving active retail participation in derivatives trading.

However, globally, derivatives trading loses money for investors. Raising investor awareness and continuous financial education is essential to warn them of the low or negative expected returns from derivatives trading.

Stock correction

A significant stock correction could result in more considerable losses for retail investors participating in capital markets through derivatives. Investors’ behavioural response would be to feel ‘cheated’ by unseen, more considerable forces. They may not return to capital markets for a long time, which is a loss to them and the economy, the Economic Survey said.

“All stakeholders – market participants, market infrastructure institutions, regulators, and the government must ensure that capital markets play their theoretically assigned role of directing savings to their most productive investments. It is not just in the national interest. It is an act of self-interest, too.”

The government’s acknowledgement of these risks underscores the need for a balanced perspective on market capitalisation.

Timely reminder

High market caps should be viewed with scepticism, especially when they are not accompanied by commensurate growth in the real economy.

The Economic Survey 2023-24 serves as a timely reminder that sustainable economic strength comes from balanced growth, where financial markets and the real economy move in tandem. Policymakers, investors, and stakeholders must heed this caution to avoid the pitfalls of over-reliance on stock market performance as a measure of economic health.