India is undergoing an astonishing stock market revolution

Those who got involved early have benefited from a jaw-dropping rally. In dollar terms, Indian stocks have risen in price by 80% over the past five years, compared with a 6% rise across emerging markets as a whole (see chart 1). Yet this joyous growth comes with growing risks. Many investors are making their first venture into financial markets, with limited knowledge of the pitfalls. The exuberant atmosphere has left India’s stocks looking extremely expensive relative to their profits. And financial liberalisation has lit a fire under derivatives markets—posing a threat to financial stability, as well as to fresh-faced investors.

The 250-rupee fund illustrates India’s financial transformation. Its sponsor is Aditya Birla Sun Life, a joint venture between an Indian conglomerate (the first two words in the name) and a Canadian insurance firm (the last two). Although Sun Life has a history in India that dates back to the 19th century, it was forced out in 1956 when the government nationalised hundreds of insurers as part of a socialist drive. A reminder of the firm’s earlier incarnation remains, in the form of a rusted Sun logo on the crumbling entry way of a building in Mumbai’s old business district.

Sun Life’s return, just before the turn of the millennium, and new plans for growth reflect a shift in India’s political system. The liberalisation of finance began in the early 1990s, but did not reach large swathes of the country. Just over a decade ago bank deposits and cash accounted for two-thirds of household assets, according to BCG, a consultancy. It is now feasible for anyone to open an investment account, trade securities cheaply and have them held by a custodian. Not long ago, each of these seemingly simple steps presented less well-off investors with difficulties. Opening accounts required stacks of documents; orders were placed through brokers charging off-putting commission. Meanwhile, share certificates could be lost and were vulnerable to theft or fraud.

Digitisation of Indian finance has helped to drive the change. The country’s Unified Payments Interface, a network for electronic payments, was launched in 2016 and has since been adopted widely. It links individuals to bank accounts, thus satisfying identification requirements, and allows for almost instantaneous withdrawal of money to buy shares. The digital shift has facilitated dematerialisation—the process of transforming physical share certificates into electronic records.

As investment habits have shifted, the share of household assets held in bank deposits has fallen below half. On current trends it will reach a third by 2030 (see chart 2). A campaign backed by the mutual-funds trade association offers a mantra—“Mutual funds are the right choice"—and has been wildly successful. In August the number of mutual-fund accounts reached 205m, up from 73m in 2021. Most are small: the average holding is under $4,000. The growth is facilitated by a wave of new electronic brokers. The largest is Groww, which says it is “taking complicated stuff and making it super simple". The next largest is Zerodha: “Invest in everything."

Much of the growth has been driven by products available to humbler investors. The number of Systematic Investment Plans (SIPs), a way to invest in mutual funds, has risen from 10m to 99m in the past eight years, with contributions increasing to $24bn in 2023 (see chart 3).

The funds take monthly instalments from investors. In August they received $2.8bn, continuing a run of record monthly inflows that has, with only rare interruptions, extended back to 2016. There has also been an explosion in “demat" accounts, short for the dematerialised form in which shares are held. In August their number reached 171m, up by 54% from January last year. But the most extreme aspect of the investment boom is in derivatives trading: India now accounts for 80% of global turnover, and retail investors count for 40% of Indian trading, up from 2% in 2018.

A wave of initial public offerings (IPOs) has helped sustain the ebullient mood. In the first three quarters of this year, India’s 258 IPOs accounted for 30% of the global total by number and 12% by the amount of money raised, in an economy that makes up just over 3% of global GDP. Zomato, a delivery company, which went public in 2021, now trades at 291 times trailing earnings, the kind of multiple typically applied to a fast-growing tech firm.

There have been even more obvious signs of mania elsewhere. A share offering in August by Resourceful Automobile, which owns two Yamaha dealerships in Delhi, was oversubscribed 419 times. A recent report by India’s finance ministry warns that misselling in banking and insurance is “too rampant to be dismissed as an aberration of a few overenthusiastic sales personnel". Social-media stars promise quick and implausible returns to investors. In the more complex corners of the market, few are making money. A study by India’s financial regulator, released in September, suggests that more than 90% of individual traders in Indian futures and options lose money.

On the other side of the bet are some of the biggest quantitative trading firms in the world. Jane Street is embroiled in a legal battle with two former employees and their new employer, Millennium Management, a hedge fund. The firm alleges its erstwhile employees replicated an immensely profitable trading strategy in the Indian options market, which Millennium and the two traders deny. Legal releases revealed that the strategy made Jane Street $1bn last year, equivalent to more than a tenth of the company’s reported profits.

Indian regulators are growing increasingly uncomfortable. In October they announced new rules for the derivatives market, including ones that will raise the minimum contract size of futures and options, and increase the margin for buyers required to protect against extreme losses on some short-term options.

After a long run of strong returns, and with a new wave of inexperienced investors, the risk of disappointment is all the greater. Most Indian speculators will never have experienced a downturn. They are sure to react unhappily when one arrives. The price-to-earnings ratio of India’s large stocks, based on expectations for their results one year from now, is 23—far above the ratio of 12 for emerging-market stocks as a whole. Recent public offerings reflect nervousness. The IPO of Hyundai Motor India in October was India’s largest ever, raising $3.3bn. But the company now trades at around 7% below its IPO price. The Sensex index of Indian stocks is down by more than 7% from an all-time high in September—a small decline, but concerning in the context of stretched valuations.

There are also signs that more informed investors are pulling back. Numbers tracked by Pace 360, a wealth-management firm, show that promoters (controlling corporate shareholders of companies) have been average net sellers of almost $1bn of stock per month via the secondary market over the past 15 months, far above the level of preceding years. Foreign investors sold a net $11bn in October, the highest figure on record. There are many reasons to applaud the vibrancy and increasing inclusiveness of India’s capital market. A possible bubble could provide harsh lessons on valuation, though—at the expense of the small investors who just arrived.

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