Budget 2014: India's falling savings, inflation, investments and returns

Saikat Neogi Posted online: Tuesday, Feb 18, 2014 at 0000 hrs
In the interim budget 2014-15, the finance minister did not tinker with direct tax rates as, unlike a full-fledged budget, the vote-on-account does not make any changes to the prevailing tax rates and restricts itself to the expenditure side.

The budget explains the manner in which money is to be spent and the way it is to be raised. With the household savings rate at a nine-year low due to high inflation and a shift from financial savings to physical savings, the regular budget in June will have to address some important concerns, which will probably give some traction to individuals’ wealth management.

Falling savings

India’s savings and investment peaked at 36.8% and 38.1% of GDP, respectively, in FY08. In FY13, the overall savings rate dropped to 30.1% of GDP and investment to 34.8% of GDP. The 120-basis-point fall in the savings rate, from 31.3% in FY12 to 30.1% of GDP in FY13, was on the back of a 90-basis-point decline in household savings (which comprise 73% of total savings) to 21.9% of GDP in FY13 from 22.8% in FY12. Corporate savings, which account for 23% of total savings, fell marginally to 7.1% of GDP in FY13 from 7.3% in FY12. Public sector savings remained constant at 1.3% of GDP in FY13.

Household savings have averaged around 22% of GDP, but there has been a major shift in the composition (from financial savings to physical savings) because of high inflation and lower returns on financial instruments such as bank deposits, stocks and insurance vis-a-vis physical investments like gold and real estate. Similarly, gross capital formation fell to 34.8% of GDP in FY13 from 35.5% in FY12 and a peak of 38.1% in FY08. The widening gap between the savings and investment rate resulted in an all-time high current account deficit of 4.8% of GDP in FY13. Analysts, however, expect the savings-investment gap to narrow from 4.7%

of GDP in FY13 to 2.3% of GDP in FY14 because of lower gold imports.

Inflation and returns

In India, bank deposits comprise over 50% of total financial savings, followed by insurance and provident fund. However, in the five years between 2008-09 and 2012-13, average deposit rates remained below the consumer price index-based inflation. With the annual average CPI-based inflation touching double digits during the period, bank deposits have yielded negative returns in real terms. On the other hand, returns from gold and real estate far exceeded CPI inflation as investors preferred to park money in these assets to hedge against inflation. Bank deposit growth has also dropped in line with financial savings — it accounted for 56% of gross financial savings in FY13, down from 57.4% in FY12.

Equities account for a miniscule 3% of overall financial savings and, given the volatility in the stock markets, retail investors have stayed away from the market. They still have some preference for stocks of public sector (PSU) companies. But most PSU stocks have fallen because of political interference, a rising subsidy bill and sub-optimal business decisions. No longer value-creators, their dismal performance can be gauged from the fact that while the Sensex has given annualised returns of over 17% in the past five years, the BSE PSU index has yielded 2% between February 2009 and 2014. However, analysts say since the valuations are cheap and most of the negatives are already priced in, the dividend yield of PSU stocks will be a cushion for investors. With elections due in May and a new government likely to come to power by June, there could be some positive policy initiation, which could result in re-rating of PSU stocks.

The continued disinflation in food prices moderated CPI to a two-year low of 8.8% in January, and the WPI moderated to 5% year on year in the same month. Since the key driver of inflation is food, the sharp fall would come as a relief to the RBI. Deutsche Bank forecast shows that headline CPI is likely to moderate to 8% in the coming months although core inflation is likely to remain sticky, around 8%.

“The RBI will remain on the sideline for the rest of first half of 2014 under this scenario,” a recent research note from the bank underlines. Even the central bank’s latest communication indicated it is in the neutral zone as far as policy rates are concerned. However, with headline CPI now emerging as the nominal anchor, it could be difficult for the RBI to reduce policy interest rates yet. The communication points out that demand-side parameters are still strong and, unless aggregate demand in the economy comes off, the risks to inflation are on the higher side.

Invest for the long term

The general elections are likely to lend direction to the markets. In case of a positive mandate, cyclical stocks will get some momentum. Positive policy initiatives, such as structural reforms, removal of supply-side bottlenecks, expedition of stuck projects and boosting of capital expenditure will benefit the economy.

Brijesh Damodaran, founder and managing partner, Zeus WealthWays, says equity investors should look at stocks from an ownership point of view as returns over the long term would be higher. For debt funds, he recommends investing for a duration of over 12 months. And, with US equity making a comeback, gold may feel the heat. Even real estate is becoming less favourable with investors as prices have stagnated in the past two years.

Analysts say investments made with a long-term perspective would fetch better returns. As diversification is important for long-term wealth creation, investors must understand their risk profile, create a portfolio framework, and monitor it regularly.