That Indians are in love with fancy houses and precious metals is no secret. This only gets affirmed by the sharp rise over the past five years in the share of national savings diverted from financial assets, such as bank deposits, bonds, mutual funds, equities and insurance & pension funds, to physical ones - land, buildings and precious metals. This diversion has led to a corresponding fall in the flow of capital to productive sectors, affecting the capex cycle and economic growth.
According to Central Statistics Office (CSO) data, nearly half (46.4 per cent) of the country's gross domestic savings in 2011-12 were in physical assets - a nine-year high. At the peak of India's economic boom when GDP growth stood at 9.3 per cent in 2007-08, the corresponding ratio was a 12-year low of 29.3 per cent. The skew towards physical assets is even worse for households, including individuals who account for the bulk of total savings. In the past 10 years, households accounted for 72.6 per cent of India's gross domestic savings on an average.
Investments in real estate and precious metals soaked up two-thirds (64.2 per cent) of the personal savings in 2011-12, the highest since 1975, when physical assets accounted for nearly three-fourths of all household savings. In other words, financial instruments now attract just a third of household savings, against 52 per cent in 2007-08 (see chart).
Experts attribute this to the vicious cycle of poor economic growth, high retail inflation, rise in commodity prices and a real estate boom - each factor feeding on the other. "After the 2008 global financial crisis, a combination of high retail inflation and poor income growth in urban India moved the terms of trade in rural households and away from the urban salaried class. The former has a higher propensity to accumulate physical assets than invest in financial instruments," says Dhananjay Sinha, co-head (institutional equity), Emkay Global Financial Services.
This, in turn, dried up the capital flow to the private corporate sector and the public sector, which rely in financial instruments like equity, bonds and bank deposits to raise capital for funding of their investment plans. The end result was a sharp deceleration in the rate of capital formation - the proportion of GDP invested in fixed assets - which declined to 33.1 per cent of GDP in 2012-13 from a high of 41.5 per cent in 2007-08, according to CSO figures. "A faster increase in physical savings, especially gold, had a role to play in pulling down the capex cycle and ultimately the economic growth," says Deep Narayan Mukherjee, director (ratings), India Ratings.
Lack of domestic capital forced companies to turn to foreign investors, with India Inc resorting to external commercial borrowings to fill the widening gap between the demand for capital and its availability. In 2011-12, for instance, foreign capital inflow was equivalent to 4.5 per cent of GDP and it accounted for 12 per cent of capital formation that year, the highest level in 23 years.
Savers' love for physical assets also hit companies on the demand side, leading to poor demand growth and decline in capacity utilisation across sectors. "Real estate investments typically have lower yields than similar investment in productive assets in manufacturing and services sectors, while precious metals don't give any yield. So, a rise in the share of physical assets in the total investment pie depresses the investment yield for the entire economy. It means less income and output for every rupee of incremental investment and lower surplus for second round of investment. All of these add up to lower GDP growth," says Emkay's Sinha.
Others, however, blame it on the relative unattractiveness of financial assets and high inflation. "Despite the recent rally, the stock market hasn't gone anywhere in the past five years, while returns on bank deposits adjusted for inflation are either negative or near zero. You cannot expect people to park their savings in these assets, given the paltry returns," says Raju Bhinge, CEO, Tata Strategic Management Group.