Despite being a trillion-dollar economy with a healthy 30 per cent-plus savings rate, households in India continue to pre-dominantly invest in real estate and gold, due to the natural inflation hedge that these non-financial assets have been seen to offer in recent times.

Even among financial assets, bank deposits account for a lion’s share not because of high interest rates offered as much as safety of capital and absence of well-developed debt markets providing better fixed-income alternatives.

Capital markets, including mutual funds, account for merely 3-4 per cent of total household savings, reflecting a lack of investment culture in India. Interestingly, this percentage has remained virtually stagnant over the last decade, despite stock markets, for all their upturns and downturns, delivering a compounded annual growth rate of 16.6 per cent from 2001-02 to 2001-12.

Why the hesitation?

Why don’t Indian households, then, consider capital market as a viable asset class for investing their savings?

One reason is the structural weaknesses of the Indian capital market. It lacks both width and depth. Despite 5,000 listed companies, the top 10 stocks account for a quarter of the National Stock Exchange’s (NSE) cash equity and nearly 40 per cent of its derivative market turnover. More than 60 per cent trading is confined to five cities: Delhi, Mumbai, Ahmedabad, Chennai and Kolkata. Further, 25 brokers account for more than 40 per cent of trading volumes.

This acute market concentration and lack of financial deepening is a major roadblock in developing a nationwide equity investor culture. For that, we need to broad-base our capital market by ensuring wider investor participation in tier-II and tier-III cities and finally taking it to every district of the country. It requires expanding the financial intermediary network involving brokers, sub-brokers and other stock-market operators.

A major hindrance in developing a strong broker network has been the high membership fees imposed by stock exchanges, discouraging small and medium sized but qualified professionals to participate due to lack of initial capital. The NSE, for instance, charges a whopping Rs 1.3 crore for new membership and the total cost runs up to Rs. 2.3 crore (including Rs 1 crore net worth that corporate members have to maintain at all times).

This, it has been able to do only because of being the country’s dominant exchange with a market share of over 90 per cent in the past two decades, enabling it to also register a net profit of Rs 638 crore in 2010-11. One hopes this will now change, with the newly established MCX Stock Exchange announcing a membership fee of Rs 30 lakh and the Bombay Stock Exchange also bringing it down to these levels. Cost optimisation will reduce the added burden on brokers, freeing up their funds trapped in the exchange that serves no other purpose but to buttress the latter’s own profit margins. Brokers will be able to use the extra cash for expanding, training, sprucing up their own infrastructure and enhancing their service.

Need for education

But merely broad-basing the broker network will not help in widening capital-market participation. Equally necessary is an effective and well-coordinated countrywide investor education programme. Retail investors need to be provided better understanding of the risk-return profile of capital-market investments vis-à-vis other asset classes.

They should also be made more aware about investor-protection regulations. Stocks exchanges till now have been only been giving lip-service to these objectives. Investor education is not merely a corporate-social-responsibility issue, but a prime driver of market development. Well-informed investors ultimately help in creating a fair, rational and inclusive market system.

Another structural issue that needs to be addressed is the lack of a well-developed debt market. For a common investor, the capital market is synonymous with equity investments, reflecting ignorance about the role of debt market. Worldwide, equities account for only 10-12 per cent of trading activity on stock exchanges. Debt instruments and debt-related derivatives are major drivers of global stock markets, which is a grossly under-developed segment of Indian capital markets.

Debt markets

A major part of the Indian debt market today comprises trading in wholesale government securities, involving participation of captive institutional players such as banks and insurance companies, who are forced by the statutory liquidity regulatory norms to take exposure in these instruments. Further, the corporate bond market is virtually absent.

Thus, there is a need to lay greater emphasis on the development of debt markets to ease corporate financing and funding of large infrastructure projects in the country. That requires more broad-based investor participation. Again, it is unfortunate that the exchanges so far have paid scant attention to this segment of the capital market.

Apart from a primary market for debt instruments, it is important to simultaneously evolve a debt-based derivatives market. While interest rate futures (IRFs) were introduced as early as 2003, it found few takers. In 2001, the Reserve Bank of India introduced IRFs on 91-days Treasury bills, followed by IRFs on two- and five-year government bonds as well. However, trading in IRFs is still negligible owing to poor effort on the part of the exchanges to create a market for these instruments. IRFs will not only stimulate the primary debt market, but the development of debt-market cash and derivative platforms would provide retail investors with a choice apart from equity-based instruments.

Intervention, competition

Broad-basing the broker network, focusing on investor education and diversifying products would go a long way in ensuring greater investor participation in Indian capital markets. In addition, there is need for policy intervention in so far as lowering trading costs. Transaction costs on Indian stock exchanges are between two to 38 times more for cash and derivative segments, compared with the average figures for leading stock exchanges in the world. High transaction costs, apart from discouraging domestic traders, are forcing even foreign investors to migrate to cheaper trading platforms in other emerging countries.

The Union Government should make stock markets more cost competitive, by eliminating or at least reducing the security transaction tax (STT) and rationalising stamp duties on market transactions. The capital-markets regulator should also focus on strengthening corporate-governance norms, internationalising stock exchanges, encouraging inter-exchange cooperation, and setting up a sovereign fund for capital-market stabilisation as Brazil and some other emerging economies have done. This will ensure that our capital market is less vulnerable to macro-economic shocks from global crises.

International evidence shows that as economies move to higher income levels, stock markets play a greater role in economic development. Widening the investor base and the right policy reforms will help in attaining long-term sustainable economic growth.

(Sanjay Sehgal and Muneesh Kumar are Professors at the Department of Financial Studies, University of Delhi. The views are personal.)

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