Sustainable Capital Formation

(The following was the gist of the addresses made at an Almus Conference & at a CRISIL event in December 2022)

 

Sustainable Capital Formation

 

SEBI’s mandate revolves around three key pillars – investor protection, market development, and market regulation. Put together, SEBI’s role is to facilitate sustainable capital formation, a crucial ingredient for achieving our country’s immense economic potential.

 

The ongoing trend of formalization has given a strong fillip to domestic capital formation. How sustainably we capitalize on this welcome trend depends on all of us scrupulously preserving and strengthening the trust in the ecosystem.

 

Formalization & Financialization of Savings

 

The ongoing formalization of our economy is on the back of better network access, increased financial inclusion, and rising digitization of payments and settlements.

 

On network access, Telecom Regulatory Authority of India (TRAI) data indicates that India had over 117 crore telephone subscribers and over 82 crore internet users as of September 2022.

 

On financial inclusion, there are now well over 47 crore Jan Dhan Yojana accounts, over 55% of which have women beneficiaries.

 

On payments and settlements, ‘formal’ retail payments through digital and cheque modes shows a rapidly rising trend. For fiscal year 2014-15, such retail payments stood at 140% of GDP. By the quarter ending September 2022, they had risen to 242% of a much higher nominal GDP. 

 

This all-round formalization has aided value creators, government finances, financialization of savings, and hence all-round capital formation.   

 

The Profit After Tax (PAT) of over 3,300 listed companies tracked by CMIE registered a strong 25% Compounded Annual Growth Rate (CAGR) between the pre-Covid first half of FY20 and the first half of FY23.

 

Similarly, there has been a robust growth in tax collections. GST collections during FY19 and FY20 were at 6.2% of GDP and 6.0% of GDP respectively. In FY23 till November, GST collections are running at well over 6.8% of a much higher nominal GDP. 

 

Aided by all this, financialization of savings is also underway. The number of active dematerialized accounts have risen from less than 4.1 crores as of March 2020, to over 10.6 crores now. Supported by resilient domestic inflows, so far in FY23, our own stock markets have significantly outperformed major global and emerging market indices, with both better USD returns and lower volatility.

 

Preserving Trust: The Key to Sustainability

 

While this ongoing domestic financialization of savings augurs well for capital formation, we have a collective responsibility to ensure its sustainability. 

 

Trust is an essential ingredient to ensure this sustainability, as underscored by the experience in a section of our debt capital markets. As of November 2017, mutual funds held corporate bonds worth INR 6.3 lakh crores. By November 2022, that number had fallen to INR 3.6 lakh crores. Within this, their holdings of corporate bonds issued by the private sector had fallen from INR 5 lakh crores to INR 2 lakh crores. 

 

While many factors were at play, some of the shocks that our debt capital markets endured between 2018 and 2020 likely contributed to this drop. While significant work has been done by all stakeholders, including SEBI, to strengthen and grow the debt ecosystem during and since then, regaining trust takes time. 

 

Therefore, during relatively stable times such as now, we must invest in reinforcing all-round trust. Much work has already been undertaken around this, and the journey will continue. Here is a sample of some areas that warrant ongoing attention.

 

First and crucially, even as we reap the benefits of increased digitization, the entire ecosystem must collectively raise the awareness and expertise around proactive management of growing IT and cyber risks. Market intermediaries have a crucial lead role to play here. 

 

Second, even as we expand the set of instruments and vehicles that aid capital formation, the ecosystem must ensure the suitability and appropriateness of solutions offered to investors. The entire ecosystem must take a dim view of any mis-selling.

 

Third, related to the above, we must constantly raise the level of disclosures in the ecosystem. This spans several dimensions, such as transparently and clearly disclosing the true total costs and fees of client solutions to investors, fully disclosing any ambiguity around valuations of less liquid assets in a portfolio, and managing price sensitive information with scrupulous care. Trust feeds on truth, and sunlight remains the best disinfectant; whenever in doubt, market participants must default to disclosing risks and issues clearly and transparently.

 

Fourth, we must continually guard against unfair trading practices and market manipulation of any kind. While SEBI has significantly increased its surveillance prowess over the last few years, we are constantly having to run just to stay in the same place. 

 

It is tempting to suggest that sustainability of capital formation should be achieved through targeted regulatory enforcement. However, this is too vital and vast an objective to be delegated to regulators alone; it must be the collective responsibility of the entire ecosystem. 

 

Looking back at the issues around debt capital markets during 2018-2020, for instance, hindsight suggests that parts of the ecosystem was aware of simmering potential issues from long before. At least going forward, market participants must scrupulously follow the maxim – if you see something, say something. By looking the other way when we come across any unfair, unethical, or inappropriate acts or practices, we are endangering the sustainability of our capital formation.

 

In summary, aided by ongoing digitization and formalization, domestic capital formation is on a strong growth path. It is our collective responsibility to preserve the sustainability of such capital formation.