 "When will we shift from gold and real estate to financial assets?")
Is the trend in the composition of household savings, observed over the past few years, on the cusp of reversing? Or will elevated household inflation expectations lead to an even greater preference for physical assets?
Households in India account for an overwhelming 72.7 per cent of total gross domestic savings, a substantial portion of which have been traditionally parked in physical assets such as real estate or jewellery. However, over the past few years, there has been an even greater preference for physical assets, with such savings rising from 52.5% of total household savings in 2009-10 to 67.6% in 2012-13. As a result, financial savings as a percentage of GDP have fallen from 10.1% in 2004-05 to 7.1% in 2012-13. While they grew at a rate of 13.4% in 2012-13, in absolute terms they remain below the 2009-10 figures.
This shift in favour of physical assets has largely been on account of lower returns from financial assets and the sharp rise in inflation which effectively eroded the real return. With retail inflation averaging above 9% per cent over the past few years, real income on financial assets such as bank deposits has been almost negative. As a consequence, deposit growth has dropped to 13.5% in 2013-14. Additionally, the Centre for Monitoring Indian Economy (CMIE) estimates that both Nifty and Sensex – benchmark indices at the National Stock Exchange and the Bombay Stock Exchange, respectively – yielded a return of 2.7% and 2.4% per annum compounded from 2009-10 to 2012-13, implying negative real returns in another asset class.
Household savings in physical assets tend to be largely directed towards gold and real estate. While Indians have a penchant for gold, the asset also serves as a hedge against inflation. Investment in real estate has also delivered phenomenal returns over the past decade. Data from the National Housing Board (NHB) does indicate a rise in the real estate index in most cities, although it probably underestimates the actual real returns in the sector.
The shift has also had significant implications for the broader economy. Higher gold consumption which was effectively met through imports resulted in the widening of the current account deficit, which had a direct impact on the rupee. Additionally, greater savings in physical assets implies that funds which could have been utilized by companies are sucked out of the financial system. The question now is whether the trend will reverse? Will households persist with the current allocation or will they shift to financial savings?
Recent data does portend that a shift, albeit small, may be underway. Gold imports have been trending downwards, largely on account of the higher duty imposed by the government. Additionally, with data also pointing towards greater equity participation by retail investors over the past few months, it does raise the question as to whether these trends are transitory or whether they are indicative of a shift in the saving pattern of households.
“The shift from physical assets to financial savings is possible if inflation comes down,” says DK Joshi, chief economist at Crisil. While inflation has been trending down over the past few months and although recent data does show a reversal, there appears to be a curious divergence between inflation and inflationary expectations. The recent downward trend in inflation does not reflect in the inflation expectations survey carried out by the Reserve Bank of India. For the survey period ending June 2014, the median inflation expectation for the three months period was 14 per cent, up from 12.9 per cent in March. The median one year ahead expectation was only marginally lower at 15 per cent, down from 15.3 per cent. According to Arvind Virmani, former Chief Economic Advisor at the Finance ministry, “Inflation expectations are still unbelievably high. Actual inflation is declining and if expectations follow these, as has normally happened in the past, financial savings should increase with a decline in inflation”.
A possible explanation for this divergence rests on the line of thinking that household expectations may be driven largely by food prices, which continue to remain elevated. The possible impact of higher prices on account of a deficient monsoon will then feed into inflation expectations, suggesting that this metric may remain elevated.
However, RBI’s hawkish stance on rates coupled with government policy actions to limit inflation in the form of lower hikes in Minimum Support Prices (MSPs), the decision to release food grains and to create alternate mandis, could act as countervailing forces against inflation. Given the uncertain milieu, then, it would be premature to conclude that inflationary pressures have dissipated in the economy and in the absence of a secular decline in inflation and inflationary expectations the shift towards financial assets may not materialize.
India’s high savings rate has been instrumental in driving the boom over the past decade. While the household sector accounts for a lion’s share of total savings, a significant portion of it, more so now, remains locked up in unproductive physical assets. To meet the huge infrastructure funding requirements that the country faces, channeling household savings into the financial markets is imperative. Can a combination of monetary and fiscal policy engineer the shift?
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Households in India account for an overwhelming 72.7 per cent of total gross domestic savings, a substantial portion of which have been traditionally parked in physical assets such as real estate or jewellery. However, over the past few years, there has been an even greater preference for physical assets, with such savings rising from 52.5% of total household savings in 2009-10 to 67.6% in 2012-13. As a result, financial savings as a percentage of GDP have fallen from 10.1% in 2004-05 to 7.1% in 2012-13. While they grew at a rate of 13.4% in 2012-13, in absolute terms they remain below the 2009-10 figures.
This shift in favour of physical assets has largely been on account of lower returns from financial assets and the sharp rise in inflation which effectively eroded the real return. With retail inflation averaging above 9% per cent over the past few years, real income on financial assets such as bank deposits has been almost negative. As a consequence, deposit growth has dropped to 13.5% in 2013-14. Additionally, the Centre for Monitoring Indian Economy (CMIE) estimates that both Nifty and Sensex – benchmark indices at the National Stock Exchange and the Bombay Stock Exchange, respectively – yielded a return of 2.7% and 2.4% per annum compounded from 2009-10 to 2012-13, implying negative real returns in another asset class.
Household savings in physical assets tend to be largely directed towards gold and real estate. While Indians have a penchant for gold, the asset also serves as a hedge against inflation. Investment in real estate has also delivered phenomenal returns over the past decade. Data from the National Housing Board (NHB) does indicate a rise in the real estate index in most cities, although it probably underestimates the actual real returns in the sector.
The shift has also had significant implications for the broader economy. Higher gold consumption which was effectively met through imports resulted in the widening of the current account deficit, which had a direct impact on the rupee. Additionally, greater savings in physical assets implies that funds which could have been utilized by companies are sucked out of the financial system. The question now is whether the trend will reverse? Will households persist with the current allocation or will they shift to financial savings?
Recent data does portend that a shift, albeit small, may be underway. Gold imports have been trending downwards, largely on account of the higher duty imposed by the government. Additionally, with data also pointing towards greater equity participation by retail investors over the past few months, it does raise the question as to whether these trends are transitory or whether they are indicative of a shift in the saving pattern of households.
“The shift from physical assets to financial savings is possible if inflation comes down,” says DK Joshi, chief economist at Crisil. While inflation has been trending down over the past few months and although recent data does show a reversal, there appears to be a curious divergence between inflation and inflationary expectations. The recent downward trend in inflation does not reflect in the inflation expectations survey carried out by the Reserve Bank of India. For the survey period ending June 2014, the median inflation expectation for the three months period was 14 per cent, up from 12.9 per cent in March. The median one year ahead expectation was only marginally lower at 15 per cent, down from 15.3 per cent. According to Arvind Virmani, former Chief Economic Advisor at the Finance ministry, “Inflation expectations are still unbelievably high. Actual inflation is declining and if expectations follow these, as has normally happened in the past, financial savings should increase with a decline in inflation”.
A possible explanation for this divergence rests on the line of thinking that household expectations may be driven largely by food prices, which continue to remain elevated. The possible impact of higher prices on account of a deficient monsoon will then feed into inflation expectations, suggesting that this metric may remain elevated.
However, RBI’s hawkish stance on rates coupled with government policy actions to limit inflation in the form of lower hikes in Minimum Support Prices (MSPs), the decision to release food grains and to create alternate mandis, could act as countervailing forces against inflation. Given the uncertain milieu, then, it would be premature to conclude that inflationary pressures have dissipated in the economy and in the absence of a secular decline in inflation and inflationary expectations the shift towards financial assets may not materialize.
India’s high savings rate has been instrumental in driving the boom over the past decade. While the household sector accounts for a lion’s share of total savings, a significant portion of it, more so now, remains locked up in unproductive physical assets. To meet the huge infrastructure funding requirements that the country faces, channeling household savings into the financial markets is imperative. Can a combination of monetary and fiscal policy engineer the shift?