Prospects for Indian corporate bond markets
In a blog post in February, I argued that we have been witnessing the gradual onshoring of the Indian corporate bond market. A decade ago, the Indian corporate bond market was in New York, but it is now increasingly in Mumbai. In the past, an Indian company wanting to borrow the rupee equivalent of say a billion dollars had no choice but to borrow in the global market in foreign currency and either bear the currency risk or hedge it. Today, it is possible for even a relatively low rated borrower to raise that kind of debt in Indian rupees in the onshore market. I concluded that Indian credit markets have now reached the stage where Indian equity markets were 15 years ago: the investors are predominantly (but not exclusively) foreign, but the market is in India.
We know that over the last 15 years, the Indian equity market evolved into one in which both the markets and the investors are predominantly Indian, and we also have a good understanding of the process through which this happended. That obviously raises the question whether a similar evolution would happen in the corporate bond market as well, and what such a process would look like. I had an email exchange on this matter with Abhijeet Katte who runs an AI sim lab working on economic and social policy questions. This post expands on those discussions and presents my assessment of the prospects of success.
Governance
A major part of the equity market development story was one of governance reform and institutional development that were a prerequisite for everything else. The equity market had its share of setbacks and scandals, but policy makers responded to each of these with regulatory reforms that spurred market development. A lot of institutional development has to happen in the credit markets as well:
- Credit ratings must be seen to be credible. During the Covid-19 pandemic, some AA rated bonds issued by large non bank finance companies traded at distressed yields (credit spreads of over 10% above risk free yields) while the rating agencies had not even placed the bonds on rating watch. The issue is not whether the rating agencies were right, the issue is that the markets simply did not believe them.
- Bankruptcy law must be seen to work smoothly. The Insolvency and Bankruptcy Code 2016 has been a huge improvement over the previous legal framework where the discounted value of the ultimate recovery was close to zero, but there is a lot more work to be done. Ideally corporate bond investors should be able to obtain ultimate recovery within a reasonable time after default, and the recovery should be predictable to a great extent based on the seniority of claim and the financial position of the borrower. We are not there yet, but hopefully, we will get there over a period of time.
- Debt mutual funds Net Asset Values (NAVs) must be believable. Both in the Global Financial Crisis and during the pandemic, investors lost faith in debt mutual fund NAVs, and there was a widespread perception (largely justified) that sophisticated well connected investors exited distressed funds at par before redemption was suspended. There have been some reforms after that, but these have not yet been tested in a stressed environment.
We have gotten to the point where a large Alternative Investment Fund (AIF) is probably comfortable navigating through the governance deficit in the debt market, but a small investor is not. Reforms are impeded because unlike in the equity markets of a generation ago, the incumbents in the debt market are deeply entrenched, and enjoy the benefits of regulatory capture. Even in the equity markets, it took a series of scandals and crises to make reforms politically feasible. I like to believe that debt market reforms are moving in the right direction, but realistically, one must recognize that there are immense obstacles.
Liquidity
For a long term investor, a debt mutual fund has some liquidity advantages over a fixed deposit. If you put money in a 5-year FD and need a premature withdrawal, that comes with a significant penalty. If you buy a mutual fund that invests in long term bonds, redemption carries no penalties once you get past the point where the exit load goes away. The investment carries interest rate risk but not liquidity risk. Just as the equity investor has some view of the direction of the stock market, the debt investor has some view about interest rates that makes this risk palatable. An investor with a one year cash surplus and a favourable view on interest rates can invest in ten year bonds (directly or through a mutual fund), and capture the term structure premium embedded in an upward sloping yield curve.
At the really short end, debt mutual funds have a serious disadvantage because it takes two business days to receive the redemption proceeds of a mutual fund, while premature withdrawal of a bank deposit is instantaneous. With instant electronic fund transfer and shortening settlement cycles in the wholesale financial markets, the two day delay is an abominable anachronism that I hope will shrink over time. Also, the two day delay is not very serious for somebody who can predict redemption needs a few days in advance.
In global markets, the solution to bond market liquidity has been the bond Exchange Traded Fund (ETF). The innovation that the ETF brings to the table is that investors trade a portfolio of bonds on the exchange instead of trading a specific bond. This exploits the fact that there are serious information asymmetries and challenges in valuing a specific bond, but it is far easier to value a diversified portfolio of bonds which is exposed primarily to macroeconomic risks. During the Covid-19 pandemic, bond ETFs in the United States traded smoothly even as liquidity was severely dislocated in the underlying bonds. Unfortunately, bond ETFs have yet to take off in India.
Equitization of debt
The quickest way to jump start the bond market in India would be to tap the well developed equity culture in the country. By tranching a portfolio of investment grade corporate bonds (with say single A or even BBB ratings), it is possible to create a bottom tranche with equity like risks and returns that could attract investors from the equity market. The upper tranche would then be AAA or AA rated which could attract investors with low risk appetite. Unfortunately, this kind of financial engineering got a bad name in the Global Financial Crisis, and Indian regulators developed a deep aversion to it. Even as India has taken tentative steps towards creating a credit derivative market, the attempt has been to ensure that this market does not disintermediate the banks. Regulatory capture has been at work!
Taxation
Over the years, most of the tax advantages of debt mutual funds have been eliminated, but two advantages still remain.
- For the patient investor, a debt mutual fund offers tax deferment. If both the bank deposit and the debt mutual fund yield 6% and the tax rate is say 20%, the bank deposit compounds at 4.8% (80% of 6%) because you pay tax on the notional interest every year. The mutual fund compounds at 6% and you pay 20% tax on the accumulated interest when you redeem. Over a 10-year horizon, this amounts to an annual yield pick up of a quarter percent, and over a 20-year horizon, the annual yield pick up is about half a percent.
- It is hugely tax efficient to combine debt and equity into a single hybrid fund that receives equity tax treatment because now even the debt interest is taxed at equity capital gains rate and that too only at redemption. The alternative of an equity mutual fund combined with a bank deposit has a massive tax disadvantage.
On the flip side, the taxation regime for investment income has been quite unpredictable in India, and it is possible that some top bureaucrats are already working on a plan to eliminate the favourable tax treatment of mutual funds.
Cost
Mutual fund expense ratios are much lower than bank Net Interest Margins (NIM) and as mutual funds achieve larger scale and compete more aggressively, this cost advantage will only increase. If you think of the mutual fund yield as being the interest rate paid by the industrial borrower less the expense ratio, and the bank deposit rate as the interest rate paid by the industrial borrower less the net interest margins, it is apparent that the mutual fund should yield more for the same level of credit risk.
High Net Interest Margins are partly (but only partly) due to weak price competition among banks when it comes to Current and Saving Accounts (CASA) deposits. Historically, there has been enough lazy money in the economy for non-price competition to be an equilibrium strategy in this segment. There is increasing evidence that the situation is changing. It is not clear how banks would respond to this changed environment. As I argued in an earlier blog post banks could simply accept a loss of market share in financial savings and shift to a fee based model. Alternatively, interest rate on CASA deposits could move closer to the interest rate in the money markets, with bank shareholders taking the pain in the form of a reduced Net Interest Margin. This would reduce the attractiveness of money market mutual funds without affecting other debt mutual funds. It is also possible that low cost CASA deposits are currently being used to subsidize the interest rate on term deposits, and banks could reduce term deposit interest rates when this subsidy is no longer available. That would be a boost to debt mutual funds. It appears to me that some combination of all of these strategic responses might play out.
Customer Loyalty
There are some countries in the world where it is said that you are more likely to divorce your spouse than change your bank. India was never like that, and customer loyalty to the bank was quite limited. These days, that loyalty is shrinking even further. The rise of the Unified Payment Interface (UPI) for peer to peer and person to merchant digital payments means that customer loyalty is more to the UPI App than to the underlying bank account that actually moves the money. In the beginning, banks were shortsighted enough to let the UPI App own the customer, and despite their best efforts to promote their own payment apps, there is little evidence of their ability to claw back the limited customer loyalty that they had earlier. UPI and other apps provided by Fintechs clearly provide a better customer experience, and these apps allow the customer to seamlessly access a variety of investment options including mutual funds and direct stock market investment. Mutual funds are today delighted by the inflows coming in through these channels, but years in the future, they may also come to regret the fact that they too do not own the customer.
Conclusion
Where does all this leave us? I think fundamental economic forces are pushing towards the rise of an Indian corporate bond market intermediated by mutual funds, and these forces will ultimately prevail. But governance problems, institutional weakness and regulatory capture stand in the way, and will definitely slow the process. What took 15 years in the equity market with a benign regulator might take longer in the bond market with a more hostile regulatory environment.
Posted at 6:26 pm IST on Wed, 15 Apr 2026 permanent link
Categories: banks, bond markets, Indian financial sector
Why we should not worry too much about day trading and gamification
Back in January, I wrote a couple of blog posts in which I welcomed the emergence of a new generation comfortable with equity investment and credited this group with driving the shift that has taken place from foreign to domestic sources of risk capital in India. I have received a lot of push back against this proposition from people who feel that this new generation is filled not with investors but with day traders. My critics argue that young day traders are gambling their money on short dated options and losing most of it. Would these youngsters not have been better off sticking to bank deposits like their parents? Can people who treat their gamified stock trading apps like video games be called investors in any meaningful sense?
I do accept that there is a lot of truth in these counter arguments, but I do not share the alarm and hand wringing that accompanies these claims. Gamification does not worry me because as Charles Eames said, "toys and games are the preludes to serious ideas". The two biggest problems in personal finance are (a) that people save too little, and (b) that they invest too little of their meagre savings in equity markets. If games encourage the youth to save, and to participate in equity markets, then that is to be welcomed. Yes, many of these young investors will lose money, and some of them will lose almost all their savings. But they have the huge advantage of being able to rebuild those lost savings, because they are so early in their career. Their losses should be regarded as the tuition fees that they are paying to develop a disciplined investing style later in life. And the boom in mutual fund Systematic Investment Plans (SIPs) is evidence that this generation is also learning disciplined investing.
I am much more mortified when I encounter senior citizens putting their retirement savings into some scam or the other and losing a big chunk of their wealth. Their losses are irreversible because at that stage in the life cycle, they have no opportunity to rebuild their nest egg. When we probe why the elderly are so vulnerable to such scams, the answer is often that throughout their career, they invested in safe assets that yielded too little, and late in life they have realized that their accumulated saving is not sufficient to sustain a reasonable standard of living in retirement. The elderly are gambling for redemption now, because they gambled too little early in life. They are in a much worse position than the youngsters enjoying their gamified trading app on a smartphone.
Posted at 4:11 pm IST on Mon, 30 Mar 2026 permanent link
Categories: behavioural finance, equity markets, Indian financial sector, investment, risk management
Indian banks: From credit provision to liquidity provision?
In my last three blog posts, I wrote about the emergence of large pools of domestic risk capital in India, the crowding out of foreign risk capital, the shrinking share of bank deposits in household financial savings, and the rapid growth of asset managers relative to banks.
In this post, I discuss how the Indian banking system and credit markets in general are likely to be reshaped by the changing competitive landscape, and by emerging new business opportunities.
Let us start with international bond markets which have become less important as a source of funding for the Indian corporate sector in recent years. Several factors have played a role here including global uncertainties and risk perception. But one factor that is important in the long term is the reduced cost advantage of foreign currency debt. Historically, Indian interest rates have been much higher than US interest rates making dollar debt attractive even after taking possible rupee depreciation into account. Post the Global Financial Crisis, the difference between the yields of ten year Indian Government bonds and US Treasury bonds hovered around 4%, and during periods like the taper tantrum and the pandemic, this differential crossed 6%.
But more recently, the gap between Indian and US long term government bond yields has narrowed to around 2½%. If we approximate expected inflation over the next 10 years in India and the US by their respective inflation targets of 4% and 2%, we get an expected inflation differential of 2%. The international Fisher condition states that Indian long term yields should exceed US yields by this inflation differential of 2%. Viewed in this light, recent yield differentials between India and the US are not materially higher than what is to be expected in a friction-less rational market with no country risk premium for local currency debt. India's comparative macroeconomic stability and its credible inflation targeting regime make it likely that this situation might endure.
Apart from cost advantages, Indian companies were in the past drawn to global bond markets because of their greater depth and the sheer availability of credit. Here again, Indian sources of funding (banks, private credit and domestic bond markets) have become much deeper and reliable. This again reduces the need to tap global markets and accept the currency risk that comes with that.
A good example of this greater depth of financing options in India was a deal last year in which a large Indian construction company tapped private credit to borrow $3.4 billion in Indian rupees. Apart from the size of the deal what was noteworthy was that the borrower was close to the bottom edge of an investment grade rating from Indian rating agencies. At a sufficiently juicy yield, Indian credit markets are now open in size to low rated borrowers.
To my mind, Indian credit markets are now where Indian equity markets were 15 years ago: the investors are predominantly (but not exclusively) foreign, but the market is in India. Over the next decade, I expect Indian investors (family offices, high net worth individuals and institutional investors) to become a larger part of this market mirroring the evolution of Indian equity markets in the previous decade.
As this happens, I think that Indian banking would move to a originate-warehouse-distribute model. It is quite likely that housing and other personal loans would be securitized in larger volumes. Even in corporate credit, banks may focus on providing liquidity rather than on funding. For example, banks have recently been allowed to provide financing for mergers and acquisitions. Globally the norm is that banks provide committed credit facilities to the acquirer which provides assurance of deal completion to the target company. After a successful acquisition, the borrower usually refinances the bank debt with bond market borrowing over a period of time. Conceptually, the ultimate source of M&A financing is the bond market (and asset sales), and the bank loans are more like bridge finance. Even in normal course of business, companies that finance themselves in the bond markets would typically have a line of credit from banks to meet liquidity shortfalls. Even asset managers would seek bank lines of credit to meet unanticipated redemption requirements. Banks are uniquely positioned to sell liquidity because of their privileged access to the central bank lending window.
Banking is likely to become more complex as these forces play out in coming years. Commercial banks that are able to think like investment banks are likely to be the winners in this process.
Posted at 2:34 pm IST on Tue, 17 Feb 2026 permanent link
Categories: banks, bond markets, Indian financial sector
Gradual end of bank dominance in India
In my last two posts, I discussed how the emergence of domestic risk capital in India could be crowding out foreign capital. By contrast till the late 2010s, India had relied on foreign risk capital, while its own financial savings went into safe assets like bank deposits and small savings. Since then, Indians have become increasingly willing to invest in equities, and there is no longer much need for foreign risk capital. In fact, rich valuations in India have dissuaded foreign capital inflows into the equity markets.
In this post, I discuss the implications of this development for the Indian financial system. More money flowing into equities means less money going into bank deposits and other safe assets. According to the Reserve Bank of India data on the Stocks of Financial Assets and Liabilities of Households, the share of bank deposits in total financial assets fell by over 4 percentage points from around 47½% in March 2021 to about 43½% in March 2025. Bank deposits plus currency fell by nearly 6 percentage points from around 59% to about 53% during the same period. The total share of all safe assets (bank deposits, currency, small savings and PPF) dropped by more than 5½ percentage points from around 69% to about 63½%. On the other hand, the share of mutual funds and pension funds rose by more than 5½ percentage points from a little over 10% to nearly 16%. The share of life insurance assets remained steady at a little below 21%.
Asset managers broadly defined (mutual funds, pension funds and insurance put together) controlled funds amounting to nearly six-sevenths (84%) of bank deposits in 2025, a significant rise from 2021 when they were less than two-thirds of bank deposits. In a few years time, we can expect asset managers to attain parity with banks and ultimately surpass them. The emergence of such a large pool of funds in the hands of asset managers very likely sets the stage for the growth of corporate bond markets in India. I venture to assert that the era of bank dominance in the Indian financial sector is gradually coming to an end. While banks will certainly adapt, prosper and grow in absolute terms, it is very likely that the banking system will shrink as a percentage of the entire financial sector.
The major challenges that these changes pose for the banking system have not been salient so far because of anaemic credit growth in recent years. As and when private sector capital expenditure picks up, banks will find themselves having to adapt to the new environment. A big shift would probably be that banking would become more of loan origination rather than loan funding particularly for personal loans which are easiest to securitize and distribute. This shift can happen quickly because personal loans have now become the biggest component of bank credit. In March 2025, the share in total bank credit of personal loans (34.4%) comfortably exceeded that of industry (23%) and services (29.4%). Five years earlier (in March 2020), the share of personal loans (28.6%) was less than that of industry (30.9%) and only marginally higher than that of services (28%). In countries like the US, corporate credit has also moved to a originate-warehouse-distribute model, and this could happen in India as well over a longer time frame. Banking is likely to become more complex as these forces play out in coming years.
In my next piece, I will discuss what I see as the likely evolution of corporate credit in India as domestic bond markets and private credit start supplanting banks and foreign bond markets.
Posted at 3:09 pm IST on Mon, 9 Feb 2026 permanent link
Categories: banks, bond markets, Indian financial sector, mutual funds
Can domestic risk capital supplant foreign capital?
In my previous blog post, I described how and why the Indian financial system has quietly pivoted from relying on foreign risk capital to mobilizing domestic risk capital, reversing a dependence that goes back to the mid 1990s. This blog post moves on from there to discuss how much further this process of supplanting foreign capital can proceed, and if so, what would be the consequences of such a "decoupling".
As I stated in my last post, the pivot to domestic risk capital involved the creation of transparent capital markets, development of mutual funds and other institutional investors, channelling of retirement savings into equities, and the emergence of a new generation comfortable with equity investment. The factor that I did not mention earlier is the demographic dividend that India is enjoying currently. Demography is providing a significant net addition to the work force that boosts economic growth. Young entrants to the workforce also increase the savings pool. It appears to me that all these forces are there to stay, and there is little reason to believe that the pool of domestic risk capital would dry up in the years to come.
As regards foreign capital, it is prudent to prepare for a scenario of diminished inflow in coming years. The first reason for this scenario is that financial globalization probably peaked before the Global Financial Crisis of 2007-2008, and that it may at some point begin to retreat. In the last few years, we have seen a process of deglobalization in terms of cross border movement of goods and people. So far, there has not been much evidence of this process extending to services and to capital. But once countries begin to embrace autarky, restrictions on capital flows cannot be ruled out.
The second scenario is based on the proposition that even if capital flows are unimpeded, abundance of capital in India would cause the capital that was previously flowing into India to seek higher returns in other countries where risk capital is relatively more scarce. A historical parallel would illustrate this possibility: as English capital markets developed in the early nineteenth century, Dutch capital that used to flow into England in the eighteenth century was diverted to France where capital was more scarce. In other words, the very abundance of domestic capital tends to inflate valuations, reduce the returns to capital in India, and ultimately make the country less attractive to foreign investors.
While we cannot predict how the future will unfold, it is therefore quite possible that domestic capital might not just augment foreign capital but might (at least partly) supplant it. What would such a shift imply for India? The obvious macroeconomic consequence would be on the balance of payments; India might have to run a smaller current account deficit if there is a lower foreign capital inflow to finance it. This might be beneficial for the economy in the long run if it weakens the currency and makes the country more competitive in global markets (though the short term consequences might be somewhat less pleasant). But I am focused more on the financial implications than the macroeconomic ones.
What would a shift from foreign to domestic risk capital do to valuation and cost of capital? Theory suggests that foreign investors holding globally diversified portfolios would demand a lower rate of return on Indian stocks than a domestic investor investing only in the Indian market. This is because risks that are idiosyncratic to India get diversified away in a global portfolio. To take a topical example, the profitability of the Indian corporate sector would depend on how tariffs on India compare with that of its competitors. An Indian investor would worry about this risk, and would demand a risk premium for bearing this risk. For a global investor, this risk would matter very little as one country's loss would be another country's gain, and a portfolio spread across both countries would be largely unaffected. (A general rise in tariffs for all countries that reduces world trade and global economic growth would of course hurt the global investor also. But a redistribution of the same average global average tariff rate across different countries would not matter much.)
There is a lot of evidence that this diversification effect was significant till a few years back. First, companies found that attracting foreign institutions into their investor base reduced their cost of capital, and, therefore, many of them obtained shareholder approval for increasing the limit on foreign institutional shareholding from the default level of 24% to the regulatory sectoral cap of 74% or 100%. Several companies also listed in foreign stock markets to attract foreign investment. Second, the steady increase in foreign shareholding of Indian companies during the first two decades of this century could also be interpreted as foreign investors being willing to pay a higher price than domestic investors.
In the last few years however, the situation appears to have reversed with many foreign investors finding the Indian market overvalued. In the last couple of years, significant selling by foreign investors has been absorbed by domestic buyers without a major impact on stock prices. Either Indian investors are more optimistic than foreigners about the prospects of Indian companies, or they are demanding a lower rate of return on their investment. The latter would be contrary to the theoretical expectation that it is the globally diversified foreign investors who should demand a lower rate of return.
One possibility is that foreign investors are more nervous about certain risks than domestic investors. This does happen in the context of domestic political risks, but is unusual in a situation like the present where global geopolitical risks are dominant. It is of course possible that investors from historically highly globalized countries find the risks of deglobalization more terrifying than those from more insular countries. But I do not find this argument very compelling because of the robust foreign investment flows to emerging markets as a whole.
The intriguing possibility is that demographic factors are creating an inflow of funds into equities that is large enough to induce elevated valuations (and consequently depressed expected future returns). The obvious solution to this would be to encourage Indian investors to invest outside India. The historical experience that I alluded to in my previous post suggest that countries that build large pools of domestic risk capital tend to move to the next stage of exporting this capital. This would enable investors to earn a better risk adjusted return on their savings, and would also avoid a misallocation of capital arising from a depressed cost of capital.
I think the time has come for Indian financial markets and policy makers to prepare for a potential scenario in which India is simultaneously importing and exporting capital. The imported capital would provide Indian companies with a globally diversified shareholder base, while the capital export would provide Indian investors with the superior risk-return opportunities arising from globally diversified portfolios. This is a scenario in which Indian financial markets begin to finance investments in other countries with less developed capital markets (either in the neighbouring region or across the world).
Posted at 10:12 pm IST on Sat, 31 Jan 2026 permanent link
Categories: equity markets, Indian financial sector, international finance
How India pivoted from foreign to domestic risk capital
During the last decade or so, the Indian financial system has quietly pivoted from relying on foreign risk capital to mobilizing domestic risk capital, reversing a dependence that goes back to the mid 1990s. In this blog post, I will discuss how and why this change happened. In the next post, I will analyse how much further this process of supplanting foreign capital can proceed, and if so, what would be the consequences of such a "decoupling".
Let me begin with a bit of prehistory. In the era of the planned economy from the 1950s to the early 1990s, the government was the main engine of economic growth, and the principal task of the financial system was to mobilize household savings and channel it to the coffers of the government. An extensive bank branch network, a vast army of insurance agents, and the wide reach of post office savings products enabled the financial system to mobilize financial savings from every nook and corner of the country. The government preempted a huge fraction of these savings though regulatory mechanisms. For example, the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) required banks to lend more than 40% of their deposits to the government. A consequence of this entire system was that household savings were almost entirely in the form of "risk free" fixed income products. The government was the principal risk taker in this environment assuming almost all of the risks of almost any large investment project whether it was the Bhakra Nangal Dam, the Bhilai Steel Plant or the Ashok luxury hotel.
A core element of the Indian economic reforms in the early 1990s was that the government stopped doing this and decided to shift this investment burden to the private sector. An immediate problem was the availability of risk capital since Indian household savings was almost entirely in safe bank deposits and other fixed income products which could provide only debt capital. The solution that emerged almost by accident was to tap foreign risk capital by allowing foreign portfolio investors to buy non controlling minority stakes in Indian companies. When China was attracting huge flows of foreign direct investment (foreigners holding controlling majority stakes), India enjoyed a massive inflow of portfolio capital. (Much later China too "copied" India's regulatory framework for foreign portfolio capital).
It is important to note that the pressing need was not for foreign capital as such, but for foreign risk capital. To take an illustrative example, suppose India's savings rate was around 30%, and its investment rate was 31% with the gap bridged by a current account deficit of 1% of GDP. This meant that if all foreign inflow stopped, India could theoretically finance nearly 97% of the investment (30/31 =0.97) using only domestic savings. The real problem was that most of the domestic savings could only provide debt capital, and private sector investment requires equity or risk capital. It was foreign risk capital that bridged this gap. Foreign investment flows (direct and portfolio) often amounted to more than twice the amount required to meet the current account deficit. India responded to this problem of plenty by accumulating foreign exchange reserves which mainly took the form of lending to the US government (directly or indirectly). So effectively, we took a lot of risk capital from the rest of the world and sent a substantial part of it back as debt capital.
Thus an arrangement designed to alleviate short term balance of payments pressures ended up alleviating the shortage of domestic risk capital. It worked very well for many years, and there is little doubt that it enabled rapid economic growth and the creation of world beating companies. But it was not a permanent solution. Historically, countries have relied on foreign capital in early stages of their development, but successful countries have always shifted to domestic capital over a period of time. For example, the Dutch financed England when it was building its empire in India and elsewhere (often in conflict with the Dutch). But soon England shook off this dependence and began financing other countries especially the United States which in turn developed capital markets that could finance the rest of the world.
India also has succeeded in creating adequate pools of domestic risk capital, but this required many reforms each of which took many years to bear fruit. First, was the complete overhaul of the stock market with modern technology and strong regulation. Second, was the creation of investment institutions including private sector mutual funds, insurance companies and retirement savings vehicles. Third and perhaps least appreciated was the fading away of the old generation, and the coming of age of a new generation willing to look beyond bank deposits and adopt newer products if they offered better returns. The great physicist Max Planck once remarked that science progresses one funeral at a time, and in a sense the financial system also develops one funeral at a time. Generational transition was not a reform in itself, but it was what enabled other reforms to start yielding results. (For example, when private sector mutual funds were first launched they were primarily vehicles for parking corporate cash surpluses in debt securities. Individuals too invested mainly in debt oriented mutual funds. It took tax reforms and generational change to transform mutual funds into equity oriented periodic savings plans). The fourth major reform was the set of regulatory changes that allowed retirement savings vehicles (the Employees Provident Fund, the New Pension Scheme and other pension funds) to invest in equities. This move was bitterly opposed by organized labour, and the only reason that this could be pushed through was the fact that by then the equity market was perceived to be reasonably clean and transparent.
As a result of this multi-decadal process, India has reached the point where it has a large pool of domestic risk capital. Reflecting this, the ownership share of foreign portfolio investors in Indian companies listed at the National Stock Exchange (NSE) peaked just before the Covid pandemic, and has declined steadily since then. (All the data in this paragraph is from the NSE India Ownership Tracker). During the early and mid 2000s, the ownership of foreign portfolio investors had doubled from less than 10% to over 20%. After a modest transient drop during the Global Financial Crisis, this number reached an all time high of a little over 22% at the end of December 2019. From that peak, foreign ownership has fallen to less than 17% taking it back to the levels that prevailed two decades ago. Domestic institutions (including mutual funds, banks, insurance companies) now hold a larger ownership (nearly 19%) than foreign portfolio investors. Individuals own nearly 10% of NSE listed companies and if we add their holding via mutual funds, then their total ownership rises to nearly 19% which is well above that of foreign portfolio investors. All this means that foreign capital flows no longer move Indian stock prices to the extent that they did in the past.
A number of questions arise at this stage. Could the trends of the last few years reverse at least partially in coming years? Conversely, could this process go much further? If so, would this lead to a decoupling of Indian capital markets from the rest of the world? What impact would that have on the cost of capital for Indian companies? Alternatively, could India start exporting risk capital to the rest of the world? I do not have answers to any of these questions, but I will try to analyse them in my next blog post.
Posted at 8:05 pm IST on Sat, 24 Jan 2026 permanent link
Categories: equity markets, Indian financial sector, international finance