The international system post-Cold War was dominated by what scholars define as the liberal international system that was a rule- based system based on multilateral institutions, openness and institutionalised cooperation and led by the United States. The order was institutionalized in the form of the United Nations, the International Monetary Fund (IMF), the World Bank and subsequently the World Trade Organization (WTO) which collectively constituted the institutional base to the order. It was anchored on the assumptions that economic openness, relations on the basis of rules and growing interdependence will bring about stability and prosperity in global politics. This framework seemed to be stable and self-reinforcing throughout the 1990s and most of the early 2000s. Nevertheless, the modern discourses indicate that the unity of this order is being questioned. The relative deterioration of U.S. hegemony, the emergence of newly strong states developing alternative futures of global operations, and the growing geopolitical competition have created anxieties about fragmentation. Here, it is the view of the scholars that the open and rule-based system that defined liberal internationalism might be yielding to a more challenged and uncertain international system. (Ikenberry, 2011)
The strains on liberal international order are specifically manifested in the changing relations of economic interdependence in the world. Although the concept of interdependence has long been considered as stabilising, recent scholarship has indicated that the existence of highly integrated financial and economic networks may also be the tool of strategic power. According to Farrell & Newman (2019), the phenomenon is called “weaponized interdependence” in which states situated at the centre of global networks can use the structural advantage to limit access or employ coercive actions. The domination of important nodes of monetary measures like dollar-clearing systems or payment systems, in the financial field, allows a dominating state to impose sanctions and restrict the involvement into the international markets. This makes economic interdependence unbalanced and politically partisan instead of apolitical. This change is part of the disintegration of the international financial system, with states attempting to insure themselves against vulnerability and exposure to externally managed systems.
The consequences of such a change are especially important to emerging economies that are still rooted in the world of global financial markets. As opposed to the centrality of states in financial networks, the emerging economies are mostly involved in these networks and not necessarily in control. Their developmental paths are usually pegged on foreign portfolio investment (FPI), foreign borrowing and perpetual capital inflow of the developed economies. Although this kind of integration may enable access to global liquidity, it also results in structural vulnerability. Portfolio capital is volatile in nature and may leave fast in reaction to global interest rates, geopolitics, or financial uncertainty in general. The Financial Stability Report of the Reserve Bank of India states that the external shocks and global financial tightening may cause capital outflows and exchange rate volatility, which may endanger the macroeconomic stability (Reserve Bank of India, 2023). Exposure to market reversal and limited policy freedom are becoming more prevalent in a world where financial interdependence is becoming more and more politicised, as governments are forced to focus more on investor confidence and financial stability.
India, in this wider sense, is a significant example of internal financial deepening. The domestic mutual fund industry has been growing tremendously over the last ten years, with the retail investors contributing to this growth, which is witnessed by the continuous rise in assets under management and the inflow of Systematic Investment Plans (SIP) (AMFI, 2023). The country institutional investors have played an increasingly bigger role in Indian capital markets, which tend to offset changes in foreign portfolio investment. This internal consolidation of internal capital pools is an indication of a move towards increased dependence on internally mobilised savings as opposed to the sole dependence on external capital inflows. The growth of the domestic investor base in India gains a structural importance as the global financial uncertainty moves up a notch.
This paper is based on the argument that the growth of the domestic mutual fund sector in India is not merely a growth of a financial sector, but a process of internal capital mobilisation that will lead to improved financial sovereignty. India enhances its domestic institutional capacity in the capital markets and thereby it minimizes its exposure to externally imposed turbulence as well as countering the structural vulnerabilities to global financial fragmentation. Thus, the concentration of domestic capital will be part of the larger undertaking of strategic autonomy, which will help India to navigate the increasingly fragmented liberal order with more policy latitude and resilience.
Theoretical Framework: Financial Interdependence and Structural Power.
The liberalization of the international order has been synonymous with the growth of interdependent economies and financial systems on a worldwide basis. The liberal institutionalist research presupposes that economic integration and institutional collaboration will provide incentives to stability as it entrenches states in common rules, norms, and multilateral institutions. Within this framework, growing economic openness and transfers of capital across national borders have been regarded as ways of facilitating cooperation and lessening conflict between states by creating a measure of economic payoffs (Ikenberry, 2011). Liberal order was therefore based not only on political institutions but a growing international financial edifice that promoted the flow of capital and increased economic interdependence.
Nevertheless, a recent body of work in International Political Economy indicates that not all participants in the process of interdependence derive symmetric benefits. Rather, the global economic networks are usually hierarchical with some states taking central positions enabling them to enjoy disproportional influence. Farrell & Newman (2019) conceptualise this relationship as a form of weaponized interdependence, and thus state that states that occupy central nodes in global networks, including financial payment systems or banking infrastructures or communication channels can use this leverage to watch, limit, or disrupt economic activity. Interdependence, in this case, can be a possible coercion tool and allow more influential states to impose sanctions, restrict access to international markets, or pressure other system participants.
The structural aspects of financial power in international system are also highlighted in earlier scholarship focused studies. Susan Strange (1998) suggested that domination over world finance is a vital type of structural power and states and financial centres can influence the environment in which other economies are functioning. Structural financial power, unlike direct political or military power, operates through the impact of the larger system of global economic action, such as capital flows, currency systems, and forces in the financial market. The influence that states have on such structures has led to states being able to affect the opportunities as well as constraints that other states have in the world economy.
To the emerging economies, entry to the global financial networks therefore becomes a complicated dilemma. Although the global markets enable these economies to access investment, liquidity, as well as economic growth, it also causes them to be exposed to external financial shocks and imbalanced power dynamics. Relying on foreign portfolio investment and highly financial systems that are globally interdependent may introduce structural flaws especially at times of global uncertainty or geopolitical conflict. These dynamics are critical to the analysis of the efforts made by states to alleviate financial vulnerability and resilience in the face of an ever more fragmented international order.
Global Financial Volatility and Emerging Economy Vulnerability
The growing interconnection of global financial markets has grown the magnitude and rate of capital flows across national borders dramatically. Though money openness has enabled investment and economic development in most of the developing economies, it has made them more vulnerable to external shocks emanating in the advanced financial centres. The emerging markets are also highly responsive to the changes in the global liquidity conditions, fluctuations in the interest rate in the major economies, and the changes in the risk perceptions of the investors. This means that the capital flows to these economies tend to be highly volatile which increases financial instability in the times of global uncertainty.
Most of the foreign capital inflows into emerging economies occur as a foreign portfolio investment (FPI), which is generally short run and very sensitive to world financial situations. Portfolio capital is able to cross borders quickly in response to changes in the monetary policy, geopolitical tensions or global market sentiment unlike long-term foreign direct investment. The global financial crisis of 2008 and the so-called taper tantrum of 2013 were just two examples of instances where swift shifts in capital flows can result in sporadic exchange rate changes, a wiggly equity market, and an unstable macroeconomic situation in emerging markets (Rey, 2015; Eichengreen and Gupta, 2015).
These dynamics point to the asymmetry of the global financial interdependence. Due to the fact that global financial markets are still under the acute control of the institutions and monetary policies that are situated in the more developed economies, especially, the United States, the emerging markets tend to be subjected to financial spillovers that are not under their control. The global financial cycle that depends on the monetary conditions in key financial centres limits the discretionary level of national monetary policies as it happens in countries that have flexible exchange rate regimes (Rey, 2015). As a result, the emerging economies have to deal with the conflict between financial integration and financial stability.
Thus, the reinforcement of domestic financial systems and mobilization of domestic sources of capital will be a significant approach to reducing the exposure to unstable external flows. States can also mitigate overdependence on foreign portfolio investment by enhancing the domestic capital markets and increasing the presence of local institutional investors, which also increases the financial systems resiliency to external shocks.
The Rise of Domestic Institutional Investors in India
The financial environment in India has been in a fundamental change over the last 10 years that has seen the burgeoning growth of institutional investors within the country. This has seen the mutual fund industry become one of the most crucial avenues through which the household savings can be mobilised in capital markets. The industry has experienced a consistent influx of the assets under management (AUM), the growth of retail investment, and growth of the popularity of the Systematic Investment Plans (SIPs) allowing the households to invest routinely in diversified financial instruments. Data released by the Association of Mutual Funds in India (AMFI), show that the assets under management by the industry have increased exponentially; this means that in 2014 the industry had between 10 trillion Asset Under Management and by 2023 the industry has over 40 trillion Assets Under Management signifying a fast-growing domestically mobilised investment capital (AMFI, 2023). This can be observed in the consistent increase in the contribution towards Systematic Investment Plans, the inflow of SIP took place every month is over 15,000 crore in 2023. The expansion of SIP signifies the rise in the participation of the retail investors in the capital markets of India and the progressive financialisation of household savings (AMFI, 2023).
This has changed the capital markets structure of India. In the past, the capital inflows by foreign investors dominated the Indian equity markets and the market liquidity and valuation trends were significantly dictated by the inflows. Although the role of foreign investment has stayed as strong, the increasing industry of local institutional investors, especially mutual funds, insurance companies, and pension funds, has slowly formed a more balanced investor base. The role of domestic investors in stabilising the situation at the time of foreign outflows of capital has become common where the investors absorb the market shocks and ensure that liquidity is contained within the system. It can be demonstrated by the fact that, SIP inflows continue to grow.
The SIP amount contributed every month has also been rising consistently in the last few years and thus this tells us about a structural change in the household investment behaviour whereby they are now investing in market-linked financial products instead of traditional savings tools. Such a growing domestic retail base of investors has made the Indian financial markets more resilient through provision of a more stable and predictable capital flow.
Contrary to foreign investment and especially foreign portfolio investment which is very much susceptible to the world money and risk predisposition, domestic savings mobilised by mutual funds is more persistent and long-lasting orientated. As a result, the appearance of domestic institutional investors is not just the development of the financial sector, but rather the appearance of an internal base of capital that can be used to stabilize the market. Through the domestic savings invested in capital markets and productive investments, the mutual fund industry plays a role in strengthening the financial system in India and the declining impact of unstable foreign capital inflow in the local markets.
Financial Sovereignty and Strategic Autonomy
The growth of mutual funds in the domestic Indian market has far reaching implications beyond the development of the financial market. In the interconnectedness of the global finance: consolidation of domestic capital pools leads to what can be construed as financial sovereignty, the ability of a state to become less dependent on financial volatility passed down by the outside world, as well as to have a more direct control over domestic economic instability. Although the emerging economies are still kept in the global financial network, the risk of abrupt reversal of foreign portfolio investment and changes in the liquidity position in the global system can be alleviated by the increase of the internal sources of capital.
The example of increasing involvement of domestic institutional investors in India explains this trend. With the growth of the existence of mutual funds, pension funds and insurance institutions in capital markets, a more stable financial ecosystem will be formed that can absorb external shocks. Under times of foreign capital flight, local institutional buyers have become more and more forces of counter conduction by maintaining market liquidity and asset price save. Such internalisation of the capacity to invest lessens the exorbitant role of globally mobile capital and breeds the structural separation of domestic financial markets.
In an expanded International Political Economy context, the growth of sound domestic capital markets crosses on the issue of the strategic autonomy of foreign policy as well. Strategic autonomy is defined as the capacity of a state to make autonomous decisions in terms of policy without being overly constrained by outside forces. Since financial vulnerability can be converted into political and economic pressure, highly reliant states on external capital flows tend to have fewer options of policy of their own. Making domestic financial institutions stronger and increasing internal savings can thus increase the ability of a country to ride the uncertainty in the global economy whilst keeping their policy-making independent (Subramanian, 2018). In this regard, the emergence of mutual fund industry in India is not just the change in the household investment behaviour however it is more of a changing financial base that contributes to the wider strategic goals. India steadily decreases its vulnerability to external turbulent financial flows by increasing the share of domestic investors on the capital market at the same time strengthening the flexibility of the economic system. Such internal financial capacity is considered an essential foundation of long-term strategic stability in the context of an industrial environment that is typified by geopolitical competitiveness and growing politicisation of economic interdependence.
Conclusion
There are dynamic changes in the international system which have fuelled the argument on whether the liberal international order is becoming a thing of the past and the consequences of increasing geopolitical and economic fragmentation. This puts the emerging economies at new exposures in that as global financial networks are becoming more politicized and manipulation of the strategic direction of those networks, they become more vulnerable due to their deep integration in the externally driven financial systems. The unstable nature of capital flows, global liquidity conditions, as well as the asymmetry of financial interdependence all limit the policy independence of the states that continue to be very dependent on foreign investment.
In these regards, the development of the Indian domestic financial environment provides a valuable insight into how such emerging economies can address such structural issues. The mutual fund industry has increased rapidly and the increasing penetration of the domestic institutional investors has also caused the mobilisation of the internal capital and strengthening of the domestic financial markets. Through enhancing the investment position of the stock of domestic sourcing in the capital markets, India has been slowly eliminating the relative impact of the risky foreign inflows.
Although we still have access to the global financial movements the domestic financial development makes it more resilient, establishing more stable and internally based forms of capital. The aggregation of the national institutional investors is thus an important element of financial sovereignty. In such a global context of uncertainty, where geopolitical competition is increasing in intensity, the capacity to marshal domestic financial resources may be very important in maintaining greater strategic independence. The experience of India therefore explains how domestic financial deepening can be a valuable tool that helps emerging economies to manoeuvre in the changing set-up of the global political economy.
REFERENCES
Association of Mutual Funds in India. (2023). AMFI annual report 2023. Association of Mutual Funds in India.
Eichengreen, B., & Gupta, P. (2015). Tapering talk: The impact of expectations of reduced Federal Reserve security purchases on emerging markets (Policy Research Working Paper). World Bank.
Farrell, H., & Newman, A. L. (2019). Weaponized interdependence: How global economic networks shape state coercion. International Security, 44(1), 42–79.
Ikenberry, G. J. (2011). Liberal leviathan: The origins, crisis, and transformation of the American world order. Princeton University Press.
Reserve Bank of India. (2023). Financial stability report. Reserve Bank of India.
Rey, H. (2015). Dilemma not trilemma: The global financial cycle and monetary policy independence. National Bureau of Economic Research Working Paper No. 21162.
Strange, S. (1998). Mad money: When markets outgrow governments. University of Michigan Press.
Subramanian, A. (2018). Of counsel: The challenges of the Modi–Jaitley economy. Penguin Random House India.
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