It will take more than a revival in investment demand to revive India’s economic growth. There has been a sharp rise in household investment in physical assets such as real estate and valuables and a corresponding fall in financial savings and corporate investment. In FY13, little over two-third (67.6%) of all households savings went to physical assets up from a low of 51.3% in FY07 and 52.4% in FY04. This led to a decline in investments in financial savings as bank deposits, bonds, mutual funds, equity, insurance and pension funds choking-off capital flows to corporates.
“Negative real interest rates adjusted for inflation coupled with a boom in real estate and gold induced savers to increase investments in physical assets such as gold and property and cut down on financial savings such as bank deposits and equity. This raised the cost of deposit for banks increasing capital cost for corporates,” says Devendra Pant, head economist at India Ratings.
Its impact is visible in the capex by the private corporate sector. At its peak in FY08, private corporate sector accounted for nearly half (46.5%) of the all gross domestic capital formation. Their share declined to 28.9% in FY13, while household sector share shot-up to 41% from 27.5% five years ago. Public sector share declined only marginally to 22.2% last year from 23.1% in in FY08. The share of valuables during the period share shot-up to 7.9% from 2.9% earlier.
Households are the biggest contributor of investment surplus in the economy accounting for nearly three-fourth of all savings (72.7%) in FY13 while private corporate sector accounted for just under a quarter (23.4%) and the rest coming from the public sector.
This has led to a situation where there has been a 14% decline in capital formation in absolute terms by the private corporate sector at constant prices in last five year despite 40% rise in over-all capital formation during the period and more than doubling of investments by the household sector.
In contrast, there has been only been a small dip in overall investment rate from a high of 42.7% of GDP in FY11 to 41.9% in FY13 according to data from the Reserve Bank of India. In comparison, investment rate was just around 30% in FY04, the last year of Vajpayee government. In normal course, the current investment rate should have translated into GDP growth of 9% or higher given India’s incremental capital output ratio of around 4.1. Instead, GDP growth slumped top decade low in FY14 and future outlook remains muted.
According to experts the Modi government needs to reverse this by incentivising financial savings and penalizing savings in land, real estate and bullion either by ending or restricting tax break to housing sector and keeping gold imports in check.
“The new government should boost financial savings ahead of investments so as improve capital flows to the productive sectors of the economy. Historically, the rising growth cycle has followed a phase of readjustment, where the investment rate continued to decline and the savings rate began to rise above the investment rate, thereby creating a current account surplus and a decline in interest rates,” writes Dhananjay Sinha of Emkay Global Financial Services in a report market strategy post Modi victory in the general elections.
A tight leash on inflation would also prove handy in this respect. “We need low inflation and positive real rate of interest to make bank deposits viable saving options ahead of property and gold,” says Madan Sabnavis, head economist at Care Ratings.
None of this will be easy given banks and households, especially urban middle class large accumulated exposure in the real estate sector. A sharp decline in real estate price will saddle banks with non-performing assets and could trigger a back clash from urban middle class. Similarly, jewelers may react negatively if the new government continues with the import curbs on gold.
