Our benchmark indices have gone up 15 per cent year to date, largely on the back of FII inflows. Year to date inflows also stood at $11.7 billion — a record till date. However, retail participation has been low and mutual funds have seen redemptions. Major volatility in the markets over the last three years and a virtual collapse in mid-cap stocks have severely shaken the confidence of retail investors.

Although an unfavourable global economic environment played a major role in the large decline in our equity markets; deteriorating macro economic factors, failure to take forward the reforms and consequent policy logjam has kept retail investors out of investing in equities.

To complicate matters further, near double-digit risk-free returns from fixed deposits have lessened the appeal for equity as an asset class.

Since our equity markets are largely dependent on FII inflows, the risk of investing in equities heightens. During times of global risk aversion, markets become vulnerable to sharp falls as FIIs withdraw money. This clearly shows an urgent need to develop institutions which could channelise the long-term flows into equities. There is need for household savings which are currently heavily skewed towards fixed deposits, real estate and gold to be channelised into equities. With SEBI also mandating 25 per cent of public shareholding at the minimum in listed private companies, increasing retail participation in equities has become all the more important and urgent.

However, much more needs to be done on multiple fronts for the development of a healthy and broad-based equity market (both secondary and primary) through higher retail investor participation. It would require instilling confidence among retail investors to equity as an important asset class for the creation of wealth over a medium-to-long term.

Focus on corporate governance issues will improve investor confidence. Increasing retail participation in equities would require fiscal incentives in the short-term and regulatory changes in the short-to-medium term. Other suggestions include:

Reduce volatility: A must measure for long-term. Allow investment by PF/EPF in equities on a progressive manner and gradually increase the allocations to equity. These being long-term funds will provide stability to the markets. On volatility adjusted basis, equity returns are not good enough to warrant a big shift from other investment avenues.

Fiscal incentive will help in the short-term: (a) The Rajiv Gandhi Equity Savings Scheme is a step in the right direction. Progressively, the limits and deduction (currently 50 per cent of the amount invested and a ceiling of Rs 50000) should be enhanced. Moreover, the investment eligibility criteria (<Rs 10 lakh ), should be removed and extended to all.

(b) Taxable income deductions under Section 80C need to be enhanced from Rs 1 lakh. Currently, the major portion of the one lakh limit of taxable income deductions are already covered by (1) mandatory employee PF contributions and (2) necessary life insurance payments, leaving little to invest in equities with long-term duration through ELSS.

Improve participation in primary markets - A natural boost for markets generally: IPO has traditionally been the starting point for lot of investors. If SEBI insures good practices in the primary market it will have a rub-off effect in the secondary markets as well. SEBI should also look at creating liability for merchant bankers for IPOs – this would enable quality issues and reasonable pricing

Creating more liquidity - A measure for medium to long term: Market making in B1/B2 stocks could help in improving liquidity and market depth

Strict enforcement of the laws pertaining to insider trading(a case in point is very high profile arrests made in the US recently in the insider trading violation case) would also be helpful as it sets a precedent against any wrongdoing.

Most importantly, we need to create a culture for equities which would require a push in the ST through fiscal measures and in the long run this would require more sustained and structural measures to make this a pull product for investors.

A massive drive by all stakeholders through investor education would also help towards this.

(The author is Head of Research, Aditya Birla Money. The views are personal)

(This article was published on September 15, 2012)
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