An Investor's Diary---- super read

Stuff is good if only I could get it for free!

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.

Why savings are on the decline?

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.

Source: Planning Commission

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 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd 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.

Why should I buy a financial instrument?

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.

Equity trade has not been equitable

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.

Gold is just not for glitters

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.

All physical savings of households is not unproductive

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 67^th 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. 1/3^rd 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."

"Valuations in China are now higher than those in the U.S. at the height of the dot-com bubble just about any way you slice them. The average Chinese technology stock has a price-to-earnings ratio 41 percent above that of U.S. peers in 2000, while the median valuation is twice as expensive and the market capitalization-weighted average is 12 percent higher, according to data compiled by Bloomberg."

"Topping it all off, it now appears as though China’s bubble is set to spill over into Hong Kong thanks to the kind of stretched mainland valuations described above. As we reported earlier: “China's Shanghai Composite briefly rose above 4000 for the first time since 2008, but it was the surge in the Hong Kong stock market that showed the Chinese bubble is finally spilling over, in the form of a blistering rally on the Hang Seng which rose nearly 4% on immense volume which at 250 billion Hong Kong dollars ($32 billion) was three times the average daily volume over the past year and nearly 20% more than the previous record volume day in October 2007, at the height of the pre-financial crisis bubble.”