The Misconception of Liquidity as the Culprit
A prevailing argument in Indian financial circles suggests that equities are underperforming because investors can exit too easily. This view posits that abundant liquidity intensifies market declines by making selling convenient. However, this perspective mistakes the freedom to leave for the reason investors choose to do so. Markets do not underperform because capital has an exit door; they underperform when investors find better opportunities elsewhere.
If domestic liquidity were the sole driver, abundant funds should theoretically support valuations. Yet, Indian equities have fallen even as Systematic Investment Plan (SIP) contributions remained strong. Record SIP inflows in September, occurring amid market weakness, demonstrate that domestic investment appetite has not vanished. However, fresh inflows cannot guarantee rising prices when existing investors are selling, corporate earnings disappoint, or valuations fail to justify expectations. Liquidity determines how easily capital moves, not where it wants to go.
Global Context and Relative Value
The global comparison reinforces the argument that liquidity is not the primary issue. Markets in the US, South Korea, and Taiwan offer deep liquidity and efficient exit mechanisms, yet their performance diverges sharply from India’s. This year, global and emerging market indices have risen, while India sits near the bottom of the table.
When other markets outperform India, blaming liquidity alone is difficult to defend. Common market infrastructure cannot fully explain divergent outcomes. Country-specific factors, including earnings growth, valuations, taxation, sectoral opportunities, and policy predictability, must be examined. Liquidity is common to all these markets; underperformance is not. Something specific to India is at work.
The Cost of Capital and Structural Challenges
Restricting liquidity to exit is counterproductive because the exit door is also the entry door. Investors are more willing to commit capital when they know they can withdraw it without excessive friction. Making an investment easier to sell increases its attractiveness; making it harder can discourage new buyers.
However, supply pressures remain relevant. A significant portion of IPO proceeds in recent years has enabled promoters and early investors to monetize holdings rather than reinvest in companies. This creates a persistent supply of shares. The central question remains: why is demand unwilling to absorb that supply at prevailing prices?
The uncomfortable answer is that India is asking investors to pay a premium without consistently delivering premium performance. Even after corrections, pockets of the market remain expensive relative to earnings prospects and international alternatives. Foreign investors compare opportunities across geographies and will not indefinitely pay elevated multiples solely based on a long-term growth story.
Taxation and transaction costs also influence this calculation. International capital is sensitive to the total cost of investing, including regulatory uncertainty and policy predictability. These factors collectively shape a market’s competitiveness.
The Path Forward: Competing for Capital
India faces a structural challenge as global capital gravitates towards dominant themes like artificial intelligence and advanced semiconductors. India need not replicate every global trend, but it must demonstrate where its own earnings growth and productivity gains can generate attractive risk-adjusted returns.
For years, India benefited from the assumption that its growth prospects would ensure a steady supply of foreign capital. That assumption deserves reconsideration. Global investors have a wider set of opportunities, and capital is under no obligation to remain loyal to any single market.
India must shift from assuming capital will arrive to actively competing for it. This requires: 1. Making the tax and transaction-cost framework internationally competitive. 2. Maintaining a predictable, credible regulatory environment. 3. Measuring economic policy by outcomes, particularly in corporate investment, productivity, and returns on capital.
The experiences of Japan and South Korea offer useful lessons in corporate governance reforms and capital-efficiency initiatives. Reform is most effective when implementation and measurable outcomes reinforce the message to investors. Ultimately, the task is not to make capital stay, but to give capital compelling reasons to stay.