The number of initial public offering (IPOs) increased by 66% to 272 in 2023-24, a year in which the Nifty-50 index rose by 26.8%, as against an 8.2% decline the previous year. The National Stock Exchange (NSE) investor base nearly tripled to 92 million in March 2024 from March 2020.
Financial sector development is crucial for economic growth, as it lowers the cost of financial intermediation and raises the efficiency of capital allocation.
Efficient financial intermediaries provide the economy with risk-return combinations for borrowing or investing capital to augment its production potential.
While the speedy development of this sector in India has yielded multiple benefits, there exist some concerns on its unbridled expansion—which could work counterproductively in the long run.
A disproportionate dilation of the sector, called ‘over-financialization,’ could cast a shadow on economic growth as it runs the risk of a lurking financial crisis.
Signs of over-financialization: Manifestations of this phenomenon are visible in financial-market activity. First, there has been an IPO rush. India topped the global IPO market with 227 of them, totalling $12.2 billion, in the first eight months of 2024, while the number of IPOs globally declined during this period (the US and China had 133 and 69 respectively).
Along with this, the Indian stock market achieved a significant milestone in August 2024 as the total number of registered investors in India crossed the 100 million mark, according an NSE report, which noted that it took just five months to rise from 90 million.
New investors continue to enter the market at a torrid pace. Since 2021, the count of retail investors across the country has gone up dramatically, with much of this growth coming from under-penetrated regions.
Second, the IPO boom reveals some discomforting trends. While new-age technology firms raised substantial capital, less known entities have also received an over-enthusiastic response.
A Delhi-based bike dealer’s IPO was over-subscribed nearly 400 times; it wanted to raise ₹12 crore, but received bids worth a mind-blowing ₹4,800 crore.
This dealership, which operates two showrooms, has very few employees, and despite its disclosures highlighting several business risks, its IPO was swamped.
Manifold oversubscription has been the story of many other IPOs too. Exuberant investors appear to be dismissing expert analysis in their zeal to get share allotments. Kotak Institutional Equities has repeatedly warned of over-exuberance, describing the Indian market as a mix of “rightful optimism and mistaken euphoria.”
Third, the Buffett Indicator, which measures the stock market’s overall valuation relative to the country’s GDP, has been increasing steadily. India’s Buffett indicator is hovering above 1.4, indicating that the market is significantly overvalued. In this frame of analysis, if the stock market’s value is growing much faster than the actual economy, then it may be in a bubble.
The 2023-24 Economic Survey cautions us against overconfidence in markets: “The market capitalisation to GDP ratio is not necessarily a sign of economic advancement or sophistication… If equity market claims on the real economy are excessively high, it is a harbinger of market instability rather than market resilience.”
Impending perils: Current tendencies in Indian financial markets point towards over-financialization. “Financialization is a process whereby financial markets, financial institutions and financial elites gain greater influence over economic policy and economic outcomes,” according to economist Thomas Palley.
This process transforms the functioning of economic systems at both macro and micro levels. There are three principal outcomes of financialization: First, it elevates the significance of the financial sector relative to the production sector; second, it transfers income from the latter to the former; and third, it increases income inequality and contributes to wage stagnation.
As financialization gains momentum, total debts tend to rise, with financial-sector debt growing faster than non-financial sector debt. To complicate matters, gross investment spending as a share of GDP would register a downward trend, delivering a business cycle marked by weak investment in production capacity and a likely surge in residential purchases.
Large sums of money chasing IPOs suggests that investors do not see other liquid investment opportunities available to them. The big paradox here is that the net worth of households has risen along with their debt.
According to a Motilal Oswal report, the net worth of Indian households reached record 157% of GDP in the first quarter of 2024-25, thanks to a significant increase in financial assets such as shares and mutual funds. But household debt is also at a record 42% of GDP. This trend looks likely to continue.
As financial markets are at the heart of financialization, we need to rein them in without inflicting serious collateral damage on the real economy.
These are the author’s personal views.
#Lets #underestimate #risk #overfinancialization
