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Informist, Monday, Jun. 30, 2025

NEW DELHI – Notwithstanding the moderation from their lofty levels, equity valuations remain at the high end of the historical range, especially for the more volatile midcap and smallcap stocks, the Reserve Bank of India said Monday. In its Financial Stability Report, the central bank warned about the high exposure of retail investors to microcap stocks and how market corrections could expose them to risks.

The central bank said the gap between the estimated earnings growth and required earnings growth for returning to the historical valuation multiple has also reduced. Earnings forecast updates slower than the market prices and are yet to reflect the prevailing geopolitical tensions and elevated uncertainty about the direction of tariffs, the report said.

While the equity market has shown more stability compared to April, when US President Donald Trump announced reciprocal tariffs against countries, they remain on the edge, given the lack of certainty over global tariff rates. The RBI has said the current valuations may not reflect the extent of overvaluation. 

For midcap stocks, which have a market capitalisation of between INR 50 billion and 200 billion, the contribution of equity risk premium to returns remains high, RBI said. "... between earnings revisions and valuation compression, market impact could be significant in the event of adverse shocks," the report said.

As of Mar. 28, around 67% of stocks traded with price-to-earnings ratios higher than those of their respective benchmarks. According to the central bank, the ownership share of retail investors of microcap stocks far outweighs that in the large, midcap and smallcap stocks. Largecap stocks are traditionally seen as safer bets as they offer more stability.

In contrast, microcap stocks have a higher beta, but are more sensitive to changes in macroeconomic conditions. Given Indian investors' higher exposure to this category of shares, the central bank said that market corrections could expose retail investors to greater volatility, amplify their losses.

Since the Securities and Exchange Board of India took steps to strengthen the equity derivatives segment, the average daily traded value by individuals and the number of individuals trading per month declined by 14% and 12%, respectively, between December and March, the RBI said. Between December 2023 and March 2024, the average daily traded value by individuals had increased by 48% and the number of individuals trading per month more than doubled year-on-year.  End

Reported by Anand JC

Edited by Saji George Titus

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