High Mcap to GDP Ratio Not Necessarily Sign of Economic Advancement, Can Lead to Market Instability: Economic Survey

India’s equity market capitalisation reached Rs 415 lakh crore ($5 trillion) in May 2024, placing it fifth in the global ranking. The growth came on the back of significant interest from domestic and retail investors in Indian market as an attractive investment destination and sustained IPO activity, according to the Economic Survey presented by Finance Minister Nirmala Sitharaman ahead of the Union Budget scheduled for July 23.

India’s market capitalisation (Mcap) to GDP ratio has improved to 124 per cent in FY24 compared to 77 per cent in FY19. It is significantly higher than that of other emerging market economies like China at 61 per cent Brazil at 44 per cent, and South Korea at 114 per cent.

However, CEA V Anantha Nageswaran raises caution that the mcap 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 annual document added.

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Highlighting the risks associated with Derivatives trading, the Economic Survey added that most of the new retail investors are likely young and may have a higher risk appetite which is reflected in the interest they have shown in derivatives trading, especially expiration-day trading. “While derivatives are hedging instruments, they are mostly used as speculative instruments by investors worldwide. India is likely no exception,” the document added.

According to the Economic Survey, 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.

On a global scale, derivatives trading tends to result in financial losses for the majority of investors. According to a study by the market regulator Securities and Exchange Board of India (SEBI), nine out of 10 individual investors in the equity F&O segment incurred net losses during both the years FY19 and FY22. There was a significant increase of over 500 per cent in the number of individual traders in the equity F&O segment in FY22, as compared to FY19.

Therefore, it is crucial to enhance investor awareness and provide ongoing financial education to caution them about the typically low or negative returns expected from derivatives trading. A significant stock correction could see losses that are more considerable for retail investors participating in capital markets through derivatives.

“Investors’ behavioral 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,” the Economic Survey 2024 added.

It also noted that the financialisation of economies has not ended well, even for advanced economies, for example, the global financial crisis of 2008. 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. Therefore, India needs to have an orderly and gradual evolution of the financial market,” it said.