Friday morning, 31 May 2019, was ripe with promise for stock markets. Eight thousand steaming people had witnessed the new government being sworn in. People had braved traffic and human jams at the entry gate, multiple security checks and then the worst summer day that Delhi regularly throws at its people. A 40-degree humid evening turned the water bottles kept on every seat into a hot beverage. Friday morning messages and rumours pegged Amit Shah as the next finance minister (FM) taking the markets up sharply—the markets seemed to like the fact that Shah understood the stock market and owned just short of 250 stocks himself. But as names of different ministers were announced, the market threw a small temper tantrum when its expectations were not met. But we know that markets are manic depressive in the short term and soon enough rethink the tantrum as news gets digested. By Monday morning the markets were back to feeling happy with the world and India’s first full-time woman finance minister Nirmala Sitharaman. Indira Gandhi’s brief additional charge as FM in 1970-71 leading a $62 billion GDP does not compare with the challenge Sitharaman faces to take the almost $3 trillion economy to $5 trillion over her tenure.
While the big macro problems are sure to get attention, I want to flag the issue of getting the micro right. Though the household is at the heart of the financial sector as an entrepreneur, employee, consumer, saver, investor and tax payer, much of the policy and regulatory framework relies on very academic and bookish versions of what really makes a household tick. The policy and regulatory decisions are taken assuming that a household is a utility maximising rational economic agent who will make good choices after taking informed decisions about the products available. In this context, most previous FMs have bemoaned the preference of Indian households of gold and real estate over financial assets as irrational. What they have not understood is that the problem is not on the demand side but on the supply side. The construct of the market with competing regulators for household money, of an irrational tax arbitrage between asset classes and the use of financial repression as a policy tool has kept the household suspicious of markets. They choose the safety of what they know, can see and hold over products that are invisible and mis-sold.
Indian households need a policy and regulatory environment that encourages them to trust the financial sector. Financial literacy and disclosure have been the twin legs of bouncing the responsibility of decisions onto the households without checking to see if both work. Given the large body of academic work that shows the negligible impact of financial literacy on household behaviour and the use of disclosures to obfuscate rather than inform, there are several ways ahead if we want Indian households to participate in modern finance and wean them from gold, real estate and poor-return life insurance policies. One, rethink the regulators from owning products and protecting turf to regulating the function of the product. So regulate on function and not form. Two, remove tax arbitrage between asset classes and use tax as a tool to inculcate desired behaviour. Three, move the market to a seller beware instead of a buyer beware one. Financial products are invisible and the moment of truth is far into the distance. If the onus is on the producer and seller that the household has a suitable product, we are more likely to get participation and trust rather than the current hit-and-run market. Indian households are waiting to on-board modern finance but need a market they can trust.
End note: Here is some free financial planning advice for the new FM. According to disclosures made to the Election Commission, I see that she is invested mainly in real estate, jewellery, deposits and insurance policies. She needs to step into modern financial products like mutual funds, specially ETFs and index funds, that take away the risk of the fund manager and give her the benefit of market growth, without compromising her position. One person’s money cannot move the NAV of a mutual fund, unlike that of a single stock. Having some skin in the game will also sensitize her to the way the markets in India are skewed against individuals who want to use modern financial products to create long-term wealth.