India Tries to Lure Small Investors to Stocks

by on July 25, 2012 11:52 pm BST

The Indian government’s effort to attract individuals into the stock market faces a big hurdle: Investors are increasingly disillusioned by investing.

The government plans to launch a program as early as next week to give a tax break to individuals for investing as much as 50,000 rupees ($890) in stocks each year, according to a senior official in the ministry of finance.

Divyakant Solanki/European Pressphoto Agency

Better returns are found outside India’s stock market. Above, a brokerage firm in Mumbai last year.

While that could be an incentive for individuals, it may not be enough to bring them flocking back. In recent years, retail investors have been put off by the lower returns and extreme volatility of the market, say brokers and financial advisers.

Of course, a sharp rebound in share prices could cause another rush into the market like the one between 2005 and 2007. But few observers see that soon, so the government’s efforts to stimulate investing will likely be met by a skeptical public for now.

Raja Banerji, a 39-year-old Gurgaon resident, invested in individual stocks for the first time around three years ago when, he says, two brokerage firms promised him returns of 36% and 48% annually. He invested more than 700,000 rupees. Now, his portfolio is worth 150,000 rupees.

“Even if a mad dog bites me, I’m definitely not going back into the stock market,” says Mr. Banerji.

He attributes a large part of the loss to excessive trading, including in derivatives, by his brokers. He asked his brokers to stop trading on his behalf but continues to own some stocks, hoping they will recover their value over the long term.

India’s benchmark 30-share Sensitive Index is up a total 10% over the past three years, which translates into an annual return of 4% to 5% after including dividends paid by listed companies. But that can’t match the interest rate of 8% to 9% on a typical bank deposit. Meanwhile, mutual funds that invest in gold have risen on average by 25% a year over the past three years, according to Value Research.

For many Indians, the first taste of the stock market’s allure came about seven years ago, when, between 2005 and 2007, the market soared in line with markets around the world. Many first-time investors in India bought stocks or stock mutual funds in the hopes of earning double-digit returns. Buta collapse in the global markets in 2008-2009, and more recently a slowdown in India’s economic growth, have hurt returns from stocks.

India’s government is tackling a phenomenon that has been echoed globally. In the U.S., individuals also have shied away from stocks, withdrawing billions of dollars from stock mutual funds and curbing their trading.

“Falling retail participation in equity markets is a matter of concern,” said Thomas Mathew, joint secretary of the capital markets division at India’s Department of Economic Affairs. “The underlying aim of the scheme is to develop equity culture in the country through which we can enhance depth and curb volatility.”

He said he expects the program to be officially announced in the next couple of weeks. The deduction would be available only to individuals with an annual income of less than one million rupees, and investors would have to hold their stocks for at least three years.

The average daily cash trading volume—driven largely by individual investors who actively trade in and out of stocks—on the National Stock Exchange in June was 96 billion rupees, down sharply from 219 billion rupees three years earlier.

Flows into equity mutual funds, primarily owned by individual investors, have ebbed. In the first six months of 2012, investors withdrew around 35 billion rupees from these funds, versus a net investment of 68 billion rupees in 2011.

Some financial advisers say investors are even stopping their periodic investments into funds, via systematic investment plans.

“This is mainly because people’s monthly installments for home, other loans have gone up,” says Vishal Dhawan, a financial planner in Mumbai. India’s high lending rates and inflation put a damper on people’s savings.

Individuals are increasingly choosing other investment avenues, according to brokers and some individuals.

“Why should one invest in stock markets, when you get more than 8% tax-free returns from government bonds?” said Chandrashekhar Patwardhan, a 49-year-old resident of Pune who has been an active investor in stocks for more than 10 years. This year, he said he has made only a few individual stock bets. The bulk of his investments has been in bonds, debentures and bank deposits, he says, because he believes the future for stocks looks bleak.

“I don’t think [the Sensex] will hit 20,000 level again anytime soon,” he said. Wednesday, the Sensex closed at 116846.05.

Brokers say it is important that India’s stock market has more participation from individuals to help reduce overall market volatility.

“This [tax break] is a useful tool for developing the investment culture in the country,” says Dinesh Garg, chairman at Delhi brokerage firm Quest Securities Ltd.

—Rajesh Roy contributed to this article.

Write to Ashutosh Joshi at ashutosh.joshi@dowjones.com