September 09, 2014

Reduce Speculation in Derivatives

IDFC Institute Visting Fellow in Political Economy, Praveen Chakravarty writes in Mint on the need to reduce speculation in derivatives to bridge the trust deficit and bring more retail investors into the stock market. Indeed, lack of trust in equity markets are cited as the prime reason for aversion to equity investing.

Excerpts below:

“Bring more retail investors to the stock markets,” finance minister Arun Jaitley told board members of market regulator Securities and Exchange Board of India (Sebi) at its annual board meeting on 9 August. Retail investors own just 18% of free float value of listed companies, down from 31% in 2002. In the 21st century (2000-13), net investments in equities either directly or through mutual funds by Indian investors were a paltry $17 billion (in 2014 dollars) compared with $166 billion in gold and $284 billion in bank deposits.

Sebi’s annual state of the capital markets report over the past several years reveal household surveys of retail investors that cite lack of trust in the stock markets as the prime reason for such aversion to equity investing. Ignorance, awareness and cultural incompatibility of equities are posited as potential reasons for this trust deficit. Perhaps the characteristic of India’s stock markets that are dominated by speculators betting heavily on price swings adds to such distrust. It would be insouciant of policymakers to not acknowledge this and take curative action.

Indian capital markets have the second highest ratio of derivatives trading to shares trading in the world, next to Korea, which recently introduced policies to curb such high trading by retail investors that it deemed speculative, unproductive and ominous. Amidst this backdrop, it is prudent to examine if derivatives trading in India is excessive and speculative.

The prevailing wisdom of unfettered markets misses the proverbial elephant in the room—the glaring, uncomfortable truth that India’s capital markets are dominated by speculators in derivatives. A predominantly speculative capital market primarily attracts other speculators, not investors. This breeds fear and suspicion in potential retail investors. To argue that India should not draw lessons from Korea but await evidence before acting, as some do, is naive and akin to suggesting India should have waited for its own 9/11 before implementing stricter airport security measures.

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