I have been insisting that changes in the domestic savings
pattern in past one decade are cause of concern for Indian macroeconomic
fundamentals.
Traditionally, domestic savings, especially household savings,
have been a stable and sustainable source of funding for both private as well
public investments. Though liberalization of capital controls has opened the
doors for foreign capital. It still is not a major source of funding.
In past few years the government and policymakers have
emphasized a lot on the need to increase the financial savings in the economy.
The finance minister recently claimed that many tax incentives
have been introduced to encourage household financial savings.
I sincerely believe that the government and policymakers have
not taken a holistic view of the problem and the steps taken so far are not
only inadequate but to some extent misdirected also.
I feel the issue needs to be analyzed comprehensively for making
any worthwhile step to augment household savings, especially financial savings.
For example, the following questions may need to be answered:
(a) Why the financial
savings of Indian households have declined consistently over past decade or so?
(b) Why should
households deploy their savings in financial instruments?
(c) Are Indian
corporates and governments more productive and efficient users of capital than
household savers?
(d) Why Indian
household buy gold?
To illustrate my point further I would also like to reproduce
from some of my earlier posts. Please bear with me.
Since the financial crisis of 2008, the savings rate in Indian
economy has been on the decline. From a high of ~37% of GDP in FY08, it has
declined to below 30% in the current year.
More particularly, the decline in financial savings of
households that begun in early 2000's has accelerated in recent years. This has
serious implications for the economy and therefore equity markets.
I find that household investors had began meaningful investment
in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in
80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2nd
lot of household investors. IT boom of late 90’s drew the 3rd set
to listed equity. In these three decades households invested 8-17% of their
financial savings in capital market related products.
Though the household financial savings started declining from
mid 1990’s, 2000 was the key inflection point. Since then household have
invested more in physical asserts than financial instruments.
The key cause for this trend in my view could be listed as
follows:
(a) Fall in average
age of house ownership. Higher income levels in urban areas, rise in nuclear
families and rise in real estate prices has prompted people to buy houses
earlier in their life cycle.
(b) Rise in personal
automobile ownership.
(c) Low growth in
white collar employment opportunities as compared to growth in workforce has
led to phenomenal rise in self owned enterprises leading to diversion of
savings to physical assets.
(d) Rise in gold
prices in 2000’s has definitely contributed to the trend.
(e) Negative real
rates for a material part of time.
I do not see any reason why this trend will reverse in near
future. In fact there are reasons to believe that household savings may
diminish further in next couple of years. For example consider the following:
(a) Though the rate
of inflation may decline, the absolute consumer prices for households will
remain high. Expenses on items like education, health, energy, transportation,
communication, rental, protein, and fruit and vegetable shall continue to rise
disproportionate to rise in income. Hence the savings may decline further.
(b) Implementation of
GST and subdued growth in tax collections, will slow down the wealth transfer
for at least couple of years. Lower revenue for the government, hence lower
social welfare spending growth; higher incidence of service tax; disruption of
thousands of household businesses to the advantage of large organized players;
employment restructuring as redundancies rise on a massive scale and skill
requirement change.
(c) Factors like
lower investment growth, higher productivity gains through automation &
elimination of redundancies, restructuring of PSUs shall continue to impact the
employment growth, especially for skilled labor.
(d) Lower employment opportunity
may force more and more people towards self-enterprise, leading to higher
household debt.
(e) Given the
sluggish credit growth outlook for at least 1H2015, the deposit rates may
decline further, thus de-motivating higher savings.
(f) Last but not the
least, the trend for changes in consumption pattern shall continue. Bicycle and
Transistor Radio have definitely given way to motor cycle and smart phones as
essential marriage gift (dowry) in hinterland. The running expenses are to be
paid by someone after all - be it the bridegroom, his parents or the bride's
parents.
The economic growth will have to find an alternative source of
funding (no capital control) or a way to grow household savings (lower taxes,
higher rates, cheaper houses/rent, good public health/education/transport, and
farm employment).
I have seen little effort being made in this direction so far.
I wonder whether it is appropriate for finance minister, RBI
governor, and other policy makers to think like an individual household in
formulation of broader policy framework!
We all know that buying of a financial instrument merely
signifies a transfer of money (a promissory note) in lieu of a bond, deposit
receipt or stock.
It changes the description in the balance sheet of an
individual. But it changes nothing in the aggregate balance sheet of the
country.
Then why the government or policy makers should be bothered
about it?
The question should therefore be whether the savers of money are
being adequately compensated for the consumption they are sacrificing today?
Essentially, the government and policy makers should analyze
whether:
(a) The entities to
whom household savers would assign their saved money, could produce more real
output then the savers investing that money in assets himself?
(b) Is there
sufficient empirical evidence to suggest that household financial savings have
earned more risk adjusted returns than the physical savings of households?
Will someone explain me how disinvestment of 5% shares in a
government owned enterprise (GOE) to household investors or LIC or domestic
mutual funds changes the balance sheet of the economy? As I understand it, the
effect of disinvestment is as follows:
(i) The total stock
in GOE is owned collectively by all the citizens of the country. A sale by the
government directly to household savers just transfers the ownership from
collective to individual. A sale by the government to domestic financial
institutions transfers the ownership collectively to a smaller group. No change
occurs at aggregate level.
(ii) The government
may retire some debt from the money it receives through transfer of shares in
GOE. It would save some interest at the cost of dividend and prospective rise
in the value of the stock so disinvested.
(iii) The buyer will
forgo interest and will be entitled to gain from dividend and prospective rise
in the value of the stock so purchased.
Similarly, I fail to understand what economic change will occur
if a household saver buys mutual fund units and the MF invests that money in
buying stocks from the market.
If a household saver deposits his savings in his bank account,
the bank could utilize that money in any of four ways, viz. ., (a) buy
government securities (b) deposit with RBI which in turn will buy government
securities or Fx (c) lend to a borrower and (d) do nothing.
We all know that the government borrows not for earning but for
spending. The money spend on building infrastructure does help everyone and the
economy.
But it is worth examining how much of money borrowed by the
government in past decade from domestic savers has been actually invested in
building infrastructure.
Similarly, it needs to be evaluated how much of savers' money
lend by the banks to various borrowers in past decade has actually produced
more return than the household could have earned by investing himself in
physical assets like gold, house, motor vehicle or intangible asset like
education and skill building.
It is important to highlight that the debate on indifference of
household investors towards the publicly traded equity is not only inadequate
but perhaps misdirected also. There are a number of structural and systemic
reasons for household investors' disenchantment with the listed equities.
In fact regulator and the government authorities took cognizance
of some of these reasons in recent past, and we do have yet seen a few steps
being taken. But we are still some distance from finding a sustainable cure the
malice. Some of the reasons that we found are worth noting and act upon are
listed below:
(a) In past 25yrs,
since the capital controls were removed, listed equities have not been able to
match the returns provided by traditional sources of investment like real
estate and gold. A deeper study is needed to discover how much of the rise in
market capitalization during this period is due to rise in quantum of publicly
traded equity and how much is due to rise in earnings or PE re-rating.
(b) The mutual fund
and insurance industry has grossly and consistently failed the investors in
these 25yrs decades. Except for 2-3 fund houses, most fund managers have
performed briefly and only during the bubble like conditions.
(c) Regulatory framework
has evolved over past couple of decades and is robust enough to prevent any
systemic collapse in the trade settlement. However, it has still not been able
to effectively break the malevolent promoter-operator nexus, causing frequent
cases of price manipulation.
The policy makers' anguish against gold investment by household
investors also begs few questions.
It would be interesting to know whether any systematic study has
been conducted to analyze why most Indian household savers prefer to have some
gold in their portfolio.
I had done a small survey a couple of years ago and written
about this. The following points are worth repeating.
(a)
India, unlike many western countries and China
is a country of entrepreneurs. We might have more self-employed people than G-3
taken together. Therefore, a large part of India’s households’ net worth is
invested in equity – equity of their own businesses not in listed equity – but
nonetheless equity. Empirically, gold
has never been a disproportionately large part of household wealth.
(b)
Indians
have traditionally favored physical assets over paper assets. Every Indians
aspires to have their own house. So the home equity in India is close to 100%
in most cases, unlike in many developed countries.
(c)
Most ancient cultures, China, Egypt,
Mesopotamia, Indus Valley etc. have believed in continuation of life after
death. Gold being an indestructible (and therefore sacred) object had always
been an important part of their religion, culture and beliefs since time
immemorial. You do not trade your culture and beliefs for ephemeral “money” or
"government bonds".
(d)
The gold is usually perceived as social security
and hedge against currency devaluation. The “obsession” with gold has
distinctly risen after INR devaluation and discontinuation of Rs.1000 currency
during Mrs. Gandhi’s regime. The trust deficit between the people and
government (and currency) has only widened since then.
(e)
In large parts of the country, gold is still
perceived as a status symbol. In that sense it is a huge consumption story.
This can be explained by the profligacy of developed world on branded apparels,
watches, luxury cars, electronic gadgets, and expensive vacations.
In past two decades, since 1995, India’s economy has grown at an
average rate of 6.9%. However, the total employment in economy during this
period has grown at just 0.3% CAGR.
In this period the number of self entrepreneurs has certainly
increased in the country. This has coincided with the sharp fall in public
sector employment. The aggregate private sector employment level has not been
able to compensate for fewer opportunities available in public and
unincorporated private sector. Consequently, the total number of employees on
live payrolls has fallen sharply since early 2000’s.
The combination of two – lower employment opportunities and
liberal business rules – has perhaps forced people towards entrepreneurship
that keeps them underemployed for most of the time.
The number of self owned enterprise has swelled in past one
decade. As per 67th round of NSSO survey (June 2011), there
were 58million unincorporated enterprises in India (excluding agriculture,
construction and those registered under Factories Act).
(a) Over 85% of these
enterprises are run by the owner himself, without any hired worker. 44% of
these were run from the residence of the owner. These enterprises employed
108mn people against just 39mn on the live payroll in organized sectors,
including 11mn in private sector. (Source: RBI, NSSO)
(b) These self owned
enterprises generated annual gross profit of Rs628.36bn; whereas all listed
companies in India generated gross profit of Rs610.44bn in FY12. 1/3rd of
this profit was earned by top 36 PSUs. Top 100 listed companies accounted for
over 76% of this value addition.
The point to ponder here is that given the strong equity
culture amongst Indian households, fewer employment opportunities, better
business opportunities and poor social security infrastructure - whether the
households should be incentivized to invest more in their own enterprises, home
equity, skill building, mobility and gold etc. or should they be motivated to
invest in financial instruments.
I know that it may not be a black and white proposition and a
plain "yes" or "no" answer should not be expected.
However, I would like the finance minister to consider
schemes like following, rather than ruing about low financial saving rate and
providing incentives like 80C, 80CC, 80CCD etc.
(a) Issue tradable
tax credit certificates for investments made in training and skill building for
self enterprise.
(b) Subsidy on two
wheelers and delivery vans used by self entrepreneurs operating their
businesses from home.
(c) An action plan
to oust managements of public listed companies who have failed to deliver at
least 5% CAGR in shareholder's value (dividend plus rise in share price) over
past two decades and replace it with professional management with clear
mandate.
Trivia
Mirza Ghalib famously wrote:
Bosa dete nahin aur dil pe
hai har lehzaa nigaah
Jee mein kehte hain ki muft haath aaye to maal achcha hai
(O My love you do not allow
me to kiss, but desire my love. Thinking, "the stuff is good if only I
could get it for free!")
This is what government thinks
of households' savings.
Nasdaq 1999 vs. Shanghai Composite 2014
Many analysts and market commentators have voiced serious
concerns over the huge bubble building in Chinese equities.
In a typical market frenzy - the domestic retail participation has
risen to record highs, leverage is unprecedented, disregard for valuations and
asset quality concerns audacious, and the chasm between macroeconomic &
corporate fundamentals and stock returns has widened to historic levels.
BNP Paribas in a recent report has highlighted the peril for
global markets that could come from Chinese equity bubble burst.
“Margin purchases are now accounting for almost 20% of
equities daily turnover which itself has soared to wholly unprecedented levels
in another sign of self-feeding speculative frenzy. What happens next is
clearly an ‘unknown-unknown’. By definition detached from fundamentals,
speculative bubbles are inherently re-enforcing in the short-term and
frequently last longer than expected. The longer they continue, however, the
larger the eventual bursting.”
“We certainly don’t see what could go wrong here. Last month
alone, a new investor base the size of Los Angeles — many of whom may be only
semi-literate — piled into Chinese equities which have nearly doubled in the
space of 8 months on the back of margin debt that can now be measured as a
percentage of GDP and volatility is at a 5-year high. Everything should be
fine.”
"The world-beating surge in Chinese technology stocks is making the
heady days of the dot-com bubble look tame by comparison.
The industry is leading gains in China’s $6.9 trillion stock market,
sending valuations to an average 220 times reported profits, the most expensive
level among global peers. When the Nasdaq Composite Index peaked in March 2000,
technology companies in the U.S. had a mean price-to-earnings ratio of
156."
