Policymakers and retail investors: Damned if you do, damned if you don’t

Budget noted that significant correction in stock markets could see large scale losses for retail investors trading in derivatives markets.

Budget 2024-25 announced increase of Securities Transaction Tax (STT) on futures and options of securities from 0.02 percent to 0.1 percent. Next day, SEBI in a study showed that in the cash market, seven out of 10 traders make losses. These might appear as two different stories but are highly related.

Indian policymakers connected to stock markets are caught in a dilemma. On the one hand, they make policies to promote retail investment in stock markets. On the other hand, they are making policies and educating investors on the downfall of excessive trading in stock markets. How do we explain this paradox?

SEBI’s mandate to push retail interest

The preamble of SEBI Act (1992) states the objective of SEBI as: “to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto". Based on the preamble, there are three broad functions of SEBI: protect interest of investors, development of securities markets and regulation of securities markets.

Development of securities markets is multidimensional and one aspect of development is to promote retail participation in the markets. SEBI has made many policies over the years to promote retail investment: dematerialization to streamline trading, mandating a certain retail subscription in all Initial Public Offers, pushing mutual funds etc.

The result of these efforts has been significant rise in share of stock markets in household financial assets. RBI economists in a report published in July 2024 Monthly Bulletin showed that the Indian household participation in equity market has increased over time. The share of equity investments in financial wealth has increased from 11% in 2012 to 17.6% in 2023.

Bank deposits undermined by low returns

The share of deposits has simultaneously declined from 51 percent to 43 percent due to multiple reasons.

First, the real returns on the deposits has declined over time.

Second, the advances in technology has made it really easy to trade in markets.

Much of this increase in household wealth on equity assets has been driven in the post-pandemic era as total demat accounts increased from 3.6 crore in 2018-19 to 15.8 crore at the end of May-2024.

This sudden and heightened rise in retail participation in stock market has brought the other two functions of SEBI to fore: protect interest of investors and regulation of securities markets.

The regulator is seeing increased interest of retail investors in stock markets as a cause of concern. The retail investors are participating aggressively in both cash and derivatives markets.  SEBI does not give us data separately for retail investors but includes them in ‘Others’ category.

In 2022-23, the share of others’ participation in National Stock Exchange’s cash market and derivatives market is 43 percent and 35 percent respectively. The participation of institutional investors (both foreign and domestic) has remained subdued. The high retail activity in turn has driven stock markets to touch frenzied highs. The rising stock market indices further led to retail participation.

Most retail investors make losses

In its Annual Report 2022-23, SEBI said that higher retail investors participation makes it even more imperative to push “investor education and awareness”. Apart from running investor awareness camps, SEBI released a report in 2023 which said that nine out of 10 retail investors in derivatives markets make losses. It followed up with another report in 2024, saying seven out of 10 retail investors in cash market make losses.

Both these reports show that most retail investors lose while trading in the stock market, cautioning new and existing investors to limit trading in markets. Further, SEBI executives have openly expressed concerns about froth in small and midcap markets at multiple forums but has had limited success in tampering enthusiasm of retail investors.

Finance ministry’s anxiety about savings

The Finance Ministry has joined SEBI to caution retail market investors. The Finance Ministry’s Economic Survey 2023-24 tabled before the Union Budget noted that significant correction in stock markets could see large scale losses for retail investors trading in derivatives markets. They might feel cheated and never return to capital markets, robbing the economy of their savings. The Finance Minister in the Budget raised STT on derivatives and also imposed short-term and long-term capital gains tax on financial assets.

To sum up, the last few years since the pandemic has thrown many a surprise to the watchers of Indian stock markets. As the pandemic struck, one expected stock markets to decline and remain stagnant for a long time. But what we have seen is the opposite. The market indices have not just gone on to touch higher levels with each passing day but the retail participation has also increased significantly.

The policymakers are caught in this paradox of encouraging retail participation over a long-term but also trying to limit their participation over short-term. They are trying to limit the stock market frenzy by throwing sands in the wheels of stock market participation. The retail investors should listen and act on the growing concerns over high valuations and excesses of stock markets.