Budget 2024 | Why India needs capital market reforms 2.0 to enhance economic growth

Capital markets are vital for the economic growth and development of any country. They facilitate mobilisation of funds, allocation of capital and the promotion of innovation and financial inclusion. India, as one of the fastest growing and largest emerging economies in the world, has a huge potential to leverage its capital markets to achieve its ambitious target of reaching a $7 trillion economy by 2030.

However, to realise this potential, India needs to undertake some advanced capital market reforms, or “capital market reforms 2.0”, as suggested by the Chief Economic Adviser V Anantha Nageswaran at the CII Annual Business Summit. India also needs huge amount of finance to meet its 2070 net zero targets and capital markets will need to play a huge enabler for India to do so.

If the recent trends are any indication of what the future holds, we are already on the correct path. The post-Covid era in India has witnessed a remarkable rise in retail participation and spurred on the capital markets. FIIs also continue to be bullish on India, with a net investment of ₹41,757 crore in June 2024.

To continue in this vein and attain greater heights, some of the key areas of reform that India needs to focus on are:

• • • • Expand and diversify the investor base, both domestic and foreign; deepening the market for various financial instruments.
    • • Ease the rules and regulations for raising debt and equity capital, both internally and externally.
    • • Simplify the tax structure and aligning it with international practices.

These reforms would not only increase the efficiency and integrity of the capital markets, but also lower the borrowing costs, free up resources for the private sector, attract more stable and diversified investments, and foster innovation and competitiveness.

In order to expand the domestic investor base, retail participation should be further bolstered by taking steps towards financial literacy for common Indians to educate them on alternative sources of investments such as stocks and mutual funds as compared to the perceived safer options such as Fixed deposits and gold.

On the foreign investment front, inclusion of Indian government bonds in the major global bond indexes such as the JP Morgan government bond index and the Bloomberg local currency emerging market index is a massive shot in the arm for the Indian capital markets.

As of 2022-end, foreign investors had a lowly participation of 1% in the Indian sovereign debt. Inclusion of the Government bonds in the indices shall open up the Indian government bond market to a large pool of foreign investors. As per some estimates, index inclusion has the potential to attract US$20 billion-US$40 billion initially and go upto US$180 billion over a decade. This would boost the foreign exchange reserves and the balance of payments.

Another focus area for capital market reforms is the SME segment. The SME segment holds the key for entrepreneurship, innovation and job creation. However, SMEs face many hurdles in accessing finance, such as high cost of capital, lack of collateral and complex regulations.

The capital market should offer alternative sources of funding, such as equity and debt instruments, through dedicated SME platforms to help overcome these challenges. However, these platforms require proper nurturing by way of market making, post-IPO monitoring and investor education. This shall ensure liquidity, transparency and confidence in the capital markets.

The GIFT IFSC, India’s first international financial services centre, is another promising initiative for capital market reforms. The aim of GIFT IFSC is to make India a preferred investment destination and a global financial hub by offering a range of financial products and services, such as banking, insurance, asset management, capital markets, and fintech.

The GIFT IFSC now houses the SGX Connect, which is a joint venture between the National Stock Exchange and the Singapore Exchange to create a unified order book at NSE International Exchange for USD-denominated Nifty-based products. The GIFT IFSC is also gearing up for direct listing of Indian companies on IFSC exchanges, which will enable Indian companies to access global investors and capital without the need for dual listing or depository receipts.

It shall be a match made in heaven for unlisted Indian companies and foreign investors as Indian companies shall get better valuation and foreign investors can eliminate currency risk. The regulations to enable direct listing in IFSC is under works and a light-touch regulation with adequate safeguards shall be most welcome.

Another key aspect of the capital market structure is the tax regime. While the tax rate on listed equity shares has been streamlined, the tax rates on short term capital gains on debt instruments continue to be high (30%++). In order to encourage more participation, a tax regime similar to equity shares can be extended to the listed debt instruments as well.

Further, the levy of STT which was introduced in lieu of long-term capital gains tax on equity may be revisited as the long term capital gains on equity shares are now taxable.

In conclusion, India has a great opportunity to leverage its capital markets to spur its economic growth and development and achieve its target of reaching a US$7 trillion economy by 2030. However, this would require some comprehensive capital market reforms, covering various aspects of the market structure, regulation, taxation, and innovation.

India also needs to capitalise on the recent developments, such as the global bond index inclusion and the GIFT City IFSC, which could provide a significant boost to its capital markets and economy. By doing so, India could emerge as a global financial hub and a leader in the emerging markets.

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