Capital shifting towards financial assets

Record inflow to equity funds but opinion is divided on whether this preference is temporary

Over the past 13 months, there has been a dramatic surge in capital flows into equity mutual funds (MFs).

From May 2014 to May 2015, net inflows were Rs 91,800 crore, says a report from Deutsche Bank. This is almost equal to the cumulative net inflow into MFs over the past 12 years, from January 2002 to April 2014.

Economists attribute this sudden surge to three factors -- a moderation in inflation, fall in returns from physical assets such as gold and real estate, and a booming stock market.

According to D K Joshi, chief economist at CRISIL, the ratings agency: “When inflation falls, it is logical for people to shift in favour of financial assets.” Retail inflation had averaged nine per cent annually over the past few years. This eroded real returns from financial assets such as bank deposits. With inflation moderating over the past year, real returns from bank deposits and stock markets have turned positive.

Also, over the same period, returns from gold and real estate have plummeted. Gold has fallen from Rs 28,900 per 10g in March 2014 to Rs 26,800 this month. This has had a dampening effect on investment demand. The Deutsche Bank report says the share of coins and bars, the investment component of gold demand, within overall gold consumption was 21 per cent in the fourth quarter of 2014-15 from a peak of 44 per cent in the first quarter of 2013-14.

In contrast, the BSE exchange's benchmark Sensex grew 23 per cent over the period, providing superior returns. Thus, it is likely that those looking at physical assets as an investment option have shifted to equities in this period.

This shift has significant ramifications on the broader economy. Households in India account for 72.7 per cent of total gross domestic savings and are central to funding the investment cycle. Over the past few years, they allocated a greater proportion of their savings to physical assets. The proportion rose from 52.5 per cent in 2009-10 to 67.6 per cent in 2012-13. As a consequence, the share of financial savings fell from 47.5 per cent in 2009-10 to 32.4 per cent in 2012-13. This meant that funds which could have been utilised by companies got sucked out of the financial system.

This surge in inflows into equity MFs over the past 13 months suggests a shift in favour of financial assets is underway. The Deutsche Bank report says this surge indicates a “long-pending shift in the nature of Indian household savings from physical assets to financial assets”.

The question is whether this is temporary or signals a more lasting shift in favour of financial assets over physical assets. Madan Sabnavis, chief economist at CARE Ratings, cautions against reading too much into these flows. The shift, he says, “is within financial savings and not from physical assets to financial assets. It is probably the lack of alternative investment avenues that give positive real returns that seems to be driving this shift”.

With the stock market booming over the past 18 months, households have allocated a greater proportion of their savings into equities. Not only are returns from equity investments tax-free if held over a year but the higher returns have also shielded them against inflation.

However, the trend could easily reverse. If the recent weakness in the markets persists, the lower returns could drive the money out. Weak corporate results and the absence of any conclusive evidence suggesting a firm and broad-based recovery is underway could further temper expectations and drag down the markets. This would lower the expectation of higher returns and trigger a reversal in capital flows. Sabnavis is, thus, sceptical about whether this recent trend will continue.