India should avoid a “financialisation trap” as the dominance of financial markets on policy and macroeconomic outcomes could lead to unprecedented levels of debt in both public and private sector, and a massive surge in inequality, chief economic adviser Anantha Nageswaran cautioned on Monday.
The financial sector “should remain the servant of the real economy”, he said at the CII Financing 3.0 Summit in Mumbai.
India’s stock market capitalisation of around 140% of the gross domestic product and the record profitability of the financial sector have given rise to a phenomenon which deserves closer examination, the CEA said.
Nageswaran’s comments come in the wake of a sharp rise in retail participation in the stock markets, even as the household savings are at a low ebb and indebtedness is high.
The Economic Survey 2023-24 had pointed out that the registered investor base at the NSE has nearly tripled from March 2020 to 92 million as of March 31, 2024, indicating 20% of the Indian households are now channelling their savings into financial markets.
Retail investors’ share in the equity cash segment turnover was close to 36% in 2023-24. The number of demat accounts with the depositories rose sharply to 151.4 million in FY24 from 114.5 million in FY23.
This has raised concerns about the chances of overconfidence leading to speculation and expectations of greater returns, which might not align with the real market conditions.
“When the market becomes bigger than the economy, it is natural, but not necessarily reasonable, that the considerations and priorities of the market dominate the public discourse and also influence the policy discourse. I am referring to the phenomenon called financialisation or the financial market’s dominance of policy and macroeconomic outcomes,” the CEA said.
As India looks ahead to 2047 with optimism and hope, it has to avoid this trap, because the consequences of such financialisation was there for all to see in the developed world.
“Unprecedented levels of public and private sector debt, some visible to regulators and some not, economic growth dependent on the continued increase in asset prices to offset the leverage that has built up and hence a massive surge in inequality. India must be wary of these outcomes and avoid this trap,” he said, adding that these are his personal views.
Developed countries are encountering these challenges after they have become materially prosperous, he said, adding that India was just stepping into the lower middle-income category.
“Therefore, as we deliberate on preparing our financial system to support our economic aspirations, India can ill afford the financialisation and its ramifications that afflict advanced societies. In other words, we cannot afford to let the tail wag the dog,” he said.
Observing that retaining policy autonomy and space to insulate the economy from the vagaries of global capital flows is critical, Nageswaran said India relies on global capital flows despite a modest current account deficit.
“India has one of the brightest global economic growth prospects. It is up to us to sustain it and it is also up to us to use that to our advantage in carving out policy space for ourselves,” he said.
The country has to find a fine balance between national imperatives and investor interests or preferences, he reasoned.
“It also means becoming a global agenda setter, rather than an agenda taker. That will be a good thing. While some actions can be initiated now, such as, for example, an Indian entity making the effort to become a global credit rating agency, the outcome and the impact will take much longer to materialise.”
“Economic size and economic clout will influence our ability to become a global agenda setter, and that, in turn, will favourably impact our economic performance. But agenda setting aspirations cannot run ahead of acquiring economic strength, size, heft and vitality,” he said.
The CEA also cautioned people against considering crypto assets as investment options and retail participation in derivatives.
Financialisation a potential trap, cautions Chief Economic Adviser Anantha Nageswaran