Indian Economy
India’s Shift to Domestic-led Capital Markets
- 15 Dec 2025
- 10 min read
For Prelims: Capital markets, Foreign portfolio investment (FPI), Mutual funds, Initial Public Offerings
For Mains: Role of capital markets in economic growth and financial deepening, Impact of declining FPI dependence on macroeconomic stability, Challenges of rising retail participation in equity markets
Why in News?
India’s capital markets are witnessing a structural transformation where domestic household savings are increasingly replacing foreign portfolio investment (FPI) as the primary source of market liquidity.
- While the shift has reduced exposure to volatile global capital and improved market stability, it has also highlighted concerns over unequal participation, investor protection, and inclusive growth in the run-up to Viksit Bharat 2047.
Summary
- India’s capital markets are shifting towards domestic-led growth as household savings replace foreign portfolio investment, improving stability and policy autonomy.
- However, challenges like investor protection, valuation risks, and unequal participation must be addressed to ensure inclusive growth towards Viksit Bharat 2047.
How is Domestic Money Shaping Indian Capital Markets?
- Shift in Market Ownership and Power: FPI ownership of Indian equities has declined to a 15-month low of 16.9%, and to 24.1% in the NIFTY 50.
- In contrast, domestic mutual funds are hitting record highs quarter after quarter, supported by sustained SIP inflows.
- Retail investors, through direct equity holdings and mutual funds, now own nearly 19% of the equity market, the highest level in over two decades.
- This marks a shift in market power from globally mobile capital to domestic savers, making Indian equities less vulnerable to external shocks.
- Boom in Primary Markets and Capital Formation: In 2025, domestic confidence is visible in a booming primary market, with 71 mainboard Initial Public Offerings (IPOs) raising over Rs 1 lakh crore this fiscal.
- Corporate investment announcements in FY25 rose by 39% year-on-year, with nearly 70% led by the private sector, reflecting stronger domestic risk appetite and capital mobilisation.
- Greater Market Stability: Domestic savings act as a stable, long-term anchor, dampening volatility caused by sudden FPI inflows and outflows.
- This was evident in the 2025 October rally in the NIFTY 50, where domestic flows provided a “flight-to-stability” buffer despite global uncertainty.
- Enhanced Policy Space for RBI: Reduced dependence on FPI flows gives the Reserve Bank of India (RBI) greater monetary autonomy.
- This gives RBI greater space to boost bank credit, manage the growth–inflation balance, and reduce the need for frequent rupee defence against capital flight.
- However, this policy flexibility is contingent on sustained household confidence and may quickly reverse if markets correct sharply.
Financial Markets in India
- About: Financial markets are platforms where securities like stocks, bonds, and currencies are traded.
- These markets, including forex, bond, stock, money, and derivatives markets, play a crucial role in a country's economic growth.
- Components of Financial Markets in India:
- Money Market: Deals with short-term financial instruments (less than one year), facilitating borrowing and lending between banks and financial institutions.
- Capital Markets: It involves long-term investments ( maturity period over one year). It includes the primary market (new securities) and secondary market (existing securities).
- Foreign Exchange Market: Facilitates currency trading, crucial for international trade and investment.
- Derivatives Market: Involves trading instruments like options and futures that derive value from underlying assets.
What are the Key Challenges from India’s Shift to Domestic-led Capital Markets?
- Investor Readiness and Financial Literacy Gap: Millions of new retail investors are entering equity markets, many with limited understanding of risk, cycles, and valuation.
- During market corrections, these investors are more likely to suffer losses, which can weaken long-term trust in equity markets.
- Valuation Excesses: Several IPOs and new-age companies are being priced far above their earnings and fundamentals.
- If market sentiment turns, such stretched valuations can lead to sharp corrections, disproportionately affecting small investors.
- Low Investor Returns: Despite their popularity, most active mutual funds fail to consistently outperform the market after accounting for fees and risk, yet dominate investments.
- While low-cost passive funds remain underused, reducing returns for small investors.
- Unequal Participation: Equity and mutual fund ownership remains concentrated among higher-income and urban households with better financial access.
- As a result, market gains are unevenly distributed, limiting the role of capital markets in inclusive growth.
- Corporate Governance Concerns: Declining promoter shareholding raises questions about long-term commitment and the risk of opportunistic exits.
- Stronger governance and transparency are needed to safeguard the interests of domestic savers who now anchor the markets.
What Measures are Needed to Strengthen India’s Capital Markets?
- Fix Access and Information Asymmetry: Strengthen Securities and Exchange Board of India’s investor protection framework by moving beyond disclosure under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 to suitability-based selling, simplified products, and tighter oversight of distributors, especially for first-time investors.
- Promote Low-cost Passive Investing: Encourage index funds and ETFs through lower expense ratios and investor awareness via Mutual Fund Sahi Hai campaign to address poor post-fee returns from active funds.
- Strengthen Financial Literacy and Trust: Scale up financial education under the National Strategy for Financial Education (NSFE), with focused outreach to small investors, women, and first-time market participants.
- Deepen Corporate Governance Reforms: Enforce stronger governance through the Companies Act, 2013, SEBI LODR norms, independent directors, and enhanced disclosure to ensure declining promoter stakes reflect genuine capital formation, not value extraction.
- Adopt Data-driven Inclusion Policies:Leverage data from RBI, SEBI, and NPCI, and align with Jan Dhan–Aadhaar–Mobile (JAM) and Digital India frameworks to identify access gaps and design targeted interventions for underrepresented investors.
Conclusion
The shift to domestic savings has strengthened market stability and reduced external risks, but without inclusion, literacy, and protection, this stability may prove fragile. Deepening governance, improving investor outcomes are essential to sustain growth and trust on the path to Viksit Bharat 2047.
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Drishti Mains Question: Q. Discuss how the shift from foreign portfolio investment to domestic household savings is reshaping India’s capital markets |
Frequently Asked Questions (FAQs)
1. What is driving the shift towards domestic-led capital markets in India?
Rising household savings, record SIP inflows, and increased retail participation are replacing volatile FPI flows as the main source of market liquidity.
2. How has this shift improved market stability?
Domestic savings provide long-term capital, reducing volatility caused by sudden foreign capital inflows and outflows.
3. What challenges do new retail investors face?
Limited financial literacy, exposure to overvalued IPOs, and poor post-fee returns from active funds increase downside risks.
UPSC Civil Services Examination, Previous Year Questions (PYQs)
Prelims
Q. Convertibility of rupee implies (2015)
(a) being able to convert rupee notes into gold
(b) allowing the value of rupee to be fixed by market forces
(c) freely permitting the conversion of rupee to other currencies and vice versa
(d) developing an international market for currencies in India
Ans: (c)
Mains
Q. Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments? (2019)
