Vijay Kumar Gaba

We are currently in a market phase where most asset prices are rising. Equity indices (Nifty over 22200) are close to an all-time high. Gold prices (over US$2125/oz) are at an all-time high. Bond prices (benchmark 10-year yields 7.05% from 7.50% a year ago) have recovered from their recent lows. Bitcoins (US$66000) are trading at an all-time high. Real Estate prices in India are also close to their highest levels in most metros.

The latest edition of the Handbook on Indian Statistics released by the Reserve Bank of India (RBI) depicts some interesting trends in domestic savings. Gross Domestic Savings (GDS), which was recovering steadily post demonetization, has again declined post Covid. However, the decline since FY17 is entirely due to lower savings in the corporate sector. The household savings have actually risen sharply, especially during Covid.

Contrary to popular perception, the Indian households are allocating much less to the capital market products (shares and bonds) post Covid. Even contributions to the provident funds have declined materially, indicating lower employment in the organized sector. Bank deposits have seen an increase. The contribution of Indian households to Investments (Gross Capital Formation) is stable at the elevated levels seen post demonetization, implying a rising trend towards self-employment.

Key trends

·         Gross Domestic Savings (GDS) in India that had recovered from Rs48.2trn in FY17 to Rs 60trn in FY19, declined to Rs55.9trn in FY21.

·         Household’s share in GDS increased from 58% in FY17 to 79% in FY21. During Covid it increased from 65% in FY20 to 79% in FY21. At the same time the share of the private corporate sector in GDS declined from 34% in FY17 to 30.6% in FY21.

·         The share of financial assets in household’s total savings has seen an increase from 41% in FY17 to 52.5% in FY21. In the same period the share of physical assets declined from 57.2% to 46.7%; and the share of gold and silver ornaments fell from 1.7% to 0.9%.

·         Contrary to popular perception the share of allocation to capital markets (shares and debentures) fell from a high of 9% in FY17 to 3% in FY21.

·         Household share in investment has increased from 32% in FY17 to 38% in FY21.

Indications

Post demonetization and GST, the private sector profitability (hence savings) have been impacted.

Households are increasingly becoming cautious. They are controlling their consumption and adding to savings.

Employment conditions may have worsened. More households are engaging in self-employment.

Deployment of savings in physical assets like personal vehicles, housing etc. is being avoided to maintain liquidity.

Risk appetite has been impacted adversely; and households are preferring safer bank deposits over riskier capital market assets.

 Many readers have found my thoughts on “hyperinflation” yesterday little abstract (see Hyperinflation - Highly improbable). They want me to elaborate further on why I think that “hyperinflation” is highly improbable in foreseeable future.

I do not mind sharing the bases of my views on this topic. However, before elaborating my views of “hyperinflation”, I would like to clarify that when I say “hyperinflation”, I do not mean the term in its literal sense, because in that sense it makes no sense in the present day conditions. In the current context, by hyperinflation, we should understand episodes of sustained high inflation over a period of many months.

To put this in further context, please note that “hyperinflation” is generally used to describe situations where the monthly inflation rate is greater than 50%. At this rate, an item that cost Rs1 on January 1 would cost Rs130 on January 1 of the following year. At least, in past few centuries, there is no instance of a global episode of hyperinflation. In the first half of 20^th century there were few localized episodes – the most famous being Germany (1922-23) and Hungary (1945-46).

In past 70yrs, Peru (1980s), Venezuela (2014-16), Yugoslavia (1989-1994), Armenia (1992-93), Turkmenistan (1992-93) and Zimbabwe (2004-08) have seen episodes of hyperinflation. It is conspicuous that all these episodes resulted from either geopolitical reasons (war or collapse of extant political order) or civil unrest within the country resulting in collapse of political and/or financial system. Most of the countries facing hyperinflation were either closed economies or were facing global trade restrictions or disruptions. Besides, all these economies were too small to impact global economy, trade and commerce in any significant measure whatsoever. It would therefore be totally unfounded to expect that hyperinflation could strike a major economy of the world like US, EU, Japan, China, or India in foreseeable future.

Insofar as the probability of the episodes of sustained high inflation occurring over a period of many months in a major economy is concerned, I believe that the chances of that are almost Nil in short to medium term (1-10yrs), unless a major war or civil war breaks out involving some major economies of the world, causing sustained disruption in the global supply chain. The bases of my belief, as stated below, are simple and mostly intuitive:

·         Unlike in 20^th century, the global trade and commerce is now mostly dematerialized. The material, money, and labor move digitally. The rebalancing of demand and supply equilibriums is much faster and efficient than before.

·         Demand elasticity for most products, including food and energy has increased significantly. Alternative products and sources of supply are available to mitigate the impact of any supply shock.

·         The discretionary demand dominates the consumption in most of the developed and large developing economies. The inflation for discretionary products, like electronic gadgets, personal care services, etc. is already high. A large part of global consumption (in value terms) may not be essential and could be scaled back with small effort, without having any substantial impact on human life or global order.

·         The productivity of essential goods, like food, energy, clothing etc has significantly increased in past five decades and there is enough inventory of essential goods in the world to mitigate the impact of any supply shock due to natural calamity etc.

·         The global trade and commerce is much larger, faster and easier as compared to five decade ago. An episode of higher inflation due to supply shock is not likely to last longer.

·         The global economy is significantly more integrated now as compared to first half of 20^th century. The impact of higher inflation in a major economy is more likely to spill to the global economy rather swiftly. Hence, it is highly unlikely that supply shocks in a major economy will remain unattended by global trade partners for longer periods.

·         Given the technology and advancement in the weapon systems, the chances of a prolonged war between major global powers are next to NIL.

·         The “tons of money” that we are bothering about is actually not physical money. Most of it is ‘bytes of money” or digital money. If need arises, this can be destroyed as easily as it is being created. In fact, I firmly believe that all the money created by central bankers of developed economies in past 12years shall be destroyed by the central bankers, as soon as it threatens to spark unwanted inflation.

·         There is enough spare capacity of productive infrastructure and housing, etc. in large economies to absorb excess liquidity of money. I believe that US$1trn of additional flows could be easily absorbed in Indian economy in one month, without stoking inflation of essential items.

Insofar as the reflation of depressed commodity prices (many like Zinc and Nickle have traded below cost of production for many months) is concerned, it is not something to worry about. If at all, it may actually be a cause for celebration as it would signal normalization of the global markets and may mark reversion of extraordinary monetary efforts made in past 12years. Terming this as “hyperinflation” and rushing to the “safe havens” like gold etc. to safeguard from it would actually be quixotic, in my view.

 It was particularly gloomy winter evening of 2008 in South Mumbai. The global financial markets had their knees frozen. One of the top global financial institutions, Lehman Brothers had collapsed a couple of months back. Another global financial giant Merrill Lynch lost its identity to Bank of America. Some peripheral European countries were on the brink of defaulting on their sovereign obligations. The bankers in the financial hub of India (South Mumbai) were staring at massive job losses. Numerous businesses were on the brink. Many large investors had also suffered huge losses in their portfolios. For younger investors and bankers in their 20s and 30s, the conditions were totally unprecedented. The fear, uncertainty, scale of value destruction was overwhelming as they had not experienced anything like that before. Most of the then had seen 5yrs of strong bull market in credit and capacity building in infrastructure, energy and housing. Suddenly, all the credit started to look bad and all the capacities worthless.

The US Federal Reserve (Fed) had launched its Quantitative Easing Program (QE1) a week ago. Many other central bankers, including European Central Bank (ECB) was expected to follow the Fed soon. The commitment of central bankers to do “whatever it takes” had calmed the markets only slightly.

In this setting, I had the opportunity of hearing one of the most famous global commodity traders and fund manager in person. The gentleman was in Mumbai at the invite of a local fund house which had launched a Natural Resource Fund just a few months back. This gentleman, in his idiosyncratic style and attire made a passionate pitch for investment in global commodities. He strongly argued that the massive new money printed under the QE program of central bankers will inevitably result in hyperinflationary conditions in the global economy leading to sharp rise in prices of commodities. Quoting from the classical monetary theory books, he presented some hyperbolic charts and diagrams reflecting his projections of commodity prices.

I had many questions for the debonair looking trader cum fund manager, but I chose not to ask any, since I was fully convinced that inflation is certainly not one of the threats to the global economy in foreseeable future. Any question to the expert therefore would have been plain sophistry.

In hindsight, I feel it was a right decision to go with my conviction instead of arguing with the expert and weakening my conviction. As we all know that despite multiple rounds of QE and vigorous efforts to create some inflation, the global economy has continued to struggle with deflationary forces in past 12years. Many commodities are even yet to see their respective 2007-08 prices.

In past couple of months, the hyperinflation has again started appearing in headlines. Numerous reports and articles have been written on how the global economy is fast racing towards hyperinflation. Many strategists have suggested trades for this - gold and silver being the most common. Many traders have taken positions. The Natural Resources Fund launched in 2008 is being marketed again aggressively.

Some wise and smart traders and fund managers are calling it “reflation” instead of “hyperinflation”, indicating that the price rise may be short trading opportunity and not a global trend.

Regardless, my view continues to remain the same as it was in 2008. I strongly feel that hyperinflation, as we know it from classical monetary theory, is a highly improbable event in the modern economic conditions. The present day trade and commerce dynamics, technology, and demand-supply matrices do not support any extraordinary inflationary flare up. And if the hyperinflation premise based on imminent demise of US Dollar, it may also be unfounded.