The 'financialisation' of Indian savings, explained

India has been consistently ranked among the top importers of gold globally. Ever wondered who consumes all that shiny metal? Indian households, mostly in the form of jewellery, which sometimes doubles up as savings. Indians have a habit of saving, but the bulk of household savings has been traditionally allotted to physical assets like real estate and gold. According to a 2017 RBI committee report, an average Indian household holds 84 percent of its wealth in real estate and other physical goods, 11 percent in gold and the residual 5 percent in financial assets.

But all that is changing very fast. Indians are increasingly preferring financial assets over physical assets, which has led to the ‘financialisation’ of savings in the country. The intensity of the trend in favour of financial assets can be gauged by the fact that the Assets Under Management (AUM) of the Indian mutual fund industry touched 25 trillion rupees in April, growing over four-fold in the last 10 years. Let us take a look at the broad reasons for the shift towards financial assets and its wider ramifications.

Weakness in the realty sector

With a major chunk of savings going into buying a flat or residential property, the marked slowdown in the real estate sector forced investors to redraft their strategy. Despite its ups and downs, investment in the real estate sector was considered a sure shot way to generate decent returns. As Indians continued pouring money into realty, property prices heated up and reached unsustainable levels in several property markets. The sector entered a bearish phase somewhere around 2013. The weakness was amplified by the enactment of the Real Estate (Regulation and Development) Act or RERA in May 2016 and the demonetisation of high-denomination currency notes in November of the same year. As returns from real estate diminished and the government cracked down on cash transactions, investors started ploughing funds into financial vehicles like mutual funds.

Source: Quartz

Formalisation of economy

In an attempt to boost financial inclusion, the government pushed banks to open no-frills Jan Dhan accounts for people in rural areas at an unprecedented pace. With an increase in the penetration of bank accounts, financial savings in the form of deposits jumped substantially. The enactment of goods and services tax and other regulations like RERA and Benami Transactions (Prohibition) Amendment Act, 2016, too helped in bringing the change in savings behaviour, the RBI committee report said.

Low inflation

Acting on the recommendations of a committee headed by former RBI governor Urijit Patel, India formally adopted an inflation targeting mechanism in 2015. After negotiations between the central bank and the government, a flexible inflation target of 2-6% was agreed upon. Inflation has remained within the band since August, 2014. As inflation moderated, real returns for investors from financial assets inched up, increasing their attraction.

Impact of financialisation

The change in savings behaviour is expected to have significant implications for the larger economy as well as the equity markets. Increased savings in the form of financial assets will ensure transparency in tax collections and curtail the creation of undisclosed income as it is relatively easier to invest undisclosed income into opaque physical assets like gold and real estate. A jump in tax collections is likely to improve the country’s tax revenues as a percentage of GDP, which is currently estimated to be around 12 percent, well below the global average of 15 percent. More revenues for the government translated into higher funding for economic growth. Besides improved tax collections, the movement of savings towards financial instruments like mutual funds has created a cushion for domestic equity markets, which have withstood sharp correction in prices in times of heavy selling by foreign investors.

Conclusion

The sudden liking for financial assets has, however, changed the risk profile of Indian household savings. Not everyone is competent enough to invest individually in equity or debt markets. People generally trust professional fund managers with their investments, who channel the money into equity or debt markets through mutual funds. A few recent events have brought the competence and choices of fund managers into question. For example, when DHFL defaulted on its debt obligations, mutual fund schemes that held DHFL bonds in their portfolio had to write down the value of their holdings. This meant that the schemes’ Net Asset Value decreased, impacting investors. Incidents like these make it very important for an investor to assess his risk profile. Even after taking one-off cases like DHFL into account, mutual funds are more likely to give higher returns than physical assets like real estate in the long run. Moreover, it is easier to invest in mutual funds through portals like Finserv MARKETS, which also help with financial planning in just a few clicks.

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