Introduction

As the current financial year draws to a close, it is worth introspecting on the changing preferences of small investors and attempt to look for patterns and trends driving the change. whose investments  and  returns have  seen  a  roller  coaster ride against  the changing  macroeconomic  backdrop.

The beginning of financial year gave  first signs  of  economic  slowdown, In  the  first  quarter of fiscal  year  2013/14, GDP  grew  at disappointing  4.4%. Inflation was stubbornly high, The CPI inflation hovered around 10.24%.The currency value of Indian rupee against dollar slipped to  its  all  time  low of  Rs 69 during the year, also the  persistent  current account  deficit  on  account  of huge  gold  imports  invited  regulatory  action  of  hiking  import  duties  on  yellow metal and  imposing  quantative  restrictions  on  its  imports.  Much to  their  chagrin   small  investors  who  looked  at  gold  as  a  safe  haven  for  investment  and  hedge  against  inflation soon discovered that  this asset  class  which  had  outperformed  in  the  last  few  years  would  soon  start  losing  its  sheen.

Gold as a financial Asset

The lure for the yellow metal for the Indian investor is not new.  The  cultural  milieu  of  Indian  masses  has  always   made   gold  as  an  attractive store of value . However  post  2008,  after  the  financial  crisis of  US,  when  investors   started  seeing erosion in their  dollar  denominated   wealth,  the appeal  for  gold increased more  than  ever  before.  Across  the  world   with  weakening  of  the  strongest  currency-the US  dollar,  investors  started  turning to  gold   a  safe  investment  option.  Even before the beginning of financial crisis, gold was outperforming.  The super cycle  of  commodities  that had  been  on  account  of  various  factors  such  as  FED  quantative  easing, China  and  emerging  markets  growth  story,  had  seen  a  meteoric  rise  in commodity  prices ,  where  investors  had  begun  “financialisation  of  commodities” gold    too  was  not  an  exception. In  India which  had  a huge market  for  jewelry too was seeing  a  paradigm  change  and   consumers  had  begun  looking   at  gold as  an  investment  option. Gold unlike many other asset classes offer these unique advantages

• It acts  as  a  hedge  against  inflation
• It  insulates  the  investors against  currency  depreciation
• It acts as a refuge against economic and political turmoil.
• It’s a store  of  value  for  the  cash  economy  especially  in rural  India ,  which   hitherto  is  still some distance away from financial  inclusion.

The psyche of the small Indian investor suited gold; whilst real estate has always created wealth; the myriad issues of large outlays, complex holding patterns, inheritance issues coupled with illiquidity made the small investor shy away from it. Gold on the other hand offers sensory pleasure (“I-can see-touch-and hold it”) can be bought in small quantities and above all can be encashed even in the middle of night makes the appetite for gold almost insatiable.

A large  number  of  avenues  such  as   Gold ETF , commodity  derivatives,  gold  coins  against  the  traditional  jewelry  added to where   consumers  could  avail    the  high  returns  of  yellow  metal. As  seen  in  the  graph  below the  upward  climb  in  returns of  gold   continued  from  to   till   July  2013.

       Graph1:    Daily   Prices of Gold Rs/10gm: 2008-2014

Source:  MCX

As  per  the  CSO  estimates  between 2007-08 and 2012-13, investment in valuables –gold and other precious metals, including jewellery increased five-fold from 53,592 crore to 266,482 crore.

On May 22nd. 2013, on the announcement of tapering of quantitative easing by the U.S. Fed, gold became the biggest loser internationally. However, Indian investors were still protected because of rupee depreciation, and still high inflation. The capital  flight  and  the looming  problem  of   current  account  deficit which  was  weakening  the  rupee prompted the  policy  makers  to   take  stringent  policy  actions   against gold .Being recognized  as  a  major  import  and  a  drag  on  our  current account  asset .Duty hikes and quantitative restrictions were imposed. Gold being an unproductive asset derive its value from future appeal. As more and more people flock to buy gold, the confidence on gold as an investment increases.  However due  above  reasons ,  gold  saw  a period  of   stable  to  lower  prices  and  this  convinced   investors that   gold had  seen  its  peak.  The  confidence  in  gold  investment  being lost, investors  started  taking  a  backseat  and  started looking  at  other  alternatives

Last year, India imported over 847 tons of gold but new restrictions on gold imports may bring down this figure drastically, analysts said. Festival demand has weakened due to higher prices and lower imports but consumer preferences are changing to platinum, diamond jewelry and light weight gold jewellery,   India lost its position as the single largest consumer of gold.

Inflation Index and Tax free   bonds

To wean away  the  Indian  investors  from  gold ,  the  Indian  policy  makers introduced more appealing  form  of  inflation  index  government  bonds, It  was  claimed  that  these  bonds  had  better  appeal  Unlike  their  original  form,  these  bonds  in  their  new  avatar   were  linked  to   the  CPI  index  instead  of  WPI.  However   liquidity and    predictability issues continue to bog them down.  Indian Investors preferred certainty and good returns to liquidity and showed inclination towards high coupon tax free bonds instead.

Mutual Fund and Insurance products

In India, life insurance has typically been looked at as an investment plus protection. Thus, in the investment aspect, it is not very different from mutual funds. The biggest flush of investor funds came into these products in the heyday of financial markets during 2007-2008. These are often called SIPs (Systematic Investment Plans), and ULIPs (Unit Linked Insurance Plan). They are structured to invest regular amounts systematically, mostly in the equity market. However, post the 2008 subprime crisis, market crashes, quantitative easing, and some subsequent recovery, these plans were not making much money. In addition, after 2011, when investors were walloped by high inflation, they were itching to cash in when they broke even on these investments. Consequently, in late 2013, as the equity markets inched towards new highs, mutual funds and insurance companies saw heavy redemptions by investors in these schemes. The retail  participation  in  equity  linked mutual  fund  schemes  were  strongest  in  2008,  the  retail  inflows   stood  at  Rs 32,247crores.   In  comparison  to  this  the  last  two  years  have  seen   an  outflow  of   retail   investors.  In 2013, the outflow of retail segment from these products was Rs 11162.8 crores. [1] A part of the money redeemed from these schemes has gone to high coupon and tax free bonds as the investors preferred these, even though they carry liquidity and some credit risk. These instruments had also become more attractive due to the rising interest rates in the economy resorted to by the central bank to keep inflation and depreciation of the currency under check.

Small Saving Schemes

India’s gross savings rate has declined since 2007-08, and stands at around 30.1 per cent of the GDP. Investors have allocated a part of their savings to high coupon and tax free bonds. The other part has flowed into the older favorite, small savings schemes. Many investors are flocking back to small saving schemes as investors on account of increasing number of scams in various chit funds, Investors are looking for safety that these government instruments provide. Instruments such as post office time deposits and National Savings Certificates (NSCs) are again being revisited The  post  office and  monthly  saving  schemes  make  up  substantial portion These schemes along with fixed deposits are perceived as risk free. Net Inflows this financial year are expected to   turn   positive to the tune of Rs 1,100 crore.  This is a substantial improvement   from previous years which saw a net outflow. In 2011-12, for instance, there was a gross negative outflow of Rs 21,800 crore from all small saving schemes. Although the interest  rates  in  these schemes  are  not  attractive, and  high  inflation  actually  depresses  the  real  returns ,but these  schemes  score  on  account  of safety cushion. Instruments  such  as  PPF  also  have  a  competitive  edge  on  account  of  tax  free  income they offer.

Conclusion

Some insights  about  the  investment  behavior   and  preferences   of  small  and  medium  financial investors have been  touched upon in  this article. The financial year has seen falling economic growth rates and high inflation. Both these macroeconomic variables have dented the saving rates.  As small  investors grapple with  erosion of  real returns  on account  of  high  inflation   and  low  saving  rate,   they  keep  shifting  their  investment  preferences  in  favor  of  asset  that  insulates  them against  high  inflation. A shift  from  equity  mutual  funds  and  gold  to  high  coupon  and  tax  free  bonds  is  discernable.  If RBI measures  to  tame  inflation  and  governments commitment towards  the path of  fiscal  prudence  hold  water   bringing  forth milder inflation in the coming  financial  year .The small investors  may start  showing   renewed  interest  in   equity  linked  investment  products.

Introduction

The past week has been a harbinger of turbulence in emerging market currencies. The Argentinean peso fell by over sixteen percent in official value against the US dollar. This has been the steepest ever since Argentina had defaulted on its debt in 2002.This triggered an erosion of confidence in other emerging markets. The Turkish Lira plummeted to record lows, and the South African rand too weakened. Two external macroeconomic linkages that were responsible for weakening of currencies are the uncertainty of Fed tapering, and concerns about global growth in general and China in particular. In comparison the Indian Rupee has not been affected as severely due to the proactive stance of the policy makers.

China

The recent PMI data which is recorded below fifty indicates economic contraction due to slowdown of manufacturing sector in the Chinese economy.  The  decision  of  China  to  shift   from  investment  led  growth  to  consumption led  growth   over  a  period  of time too would  have a global impact. The  fastest growing  economy  in  the world has  had a massive  appetite   for  commodities, and has seen  fastest  growth in imports from the commodity complex’ of  metals and  energy in the past decades. These commodities were funneled into its infrastructure and manufacturing sector. This was financed by underpriced massive loans from its state run banking sector, leading to huge accumulation of debt. The export growth  rates of China on  account  of slowing  of USA  and  Europe after  2008  crisis have  been  declining. In addition its   increasing debt overhang has forced its policy makers to  veer  their gigantic  economy towards consumption led  growth .The  commodity  exporting   emerging  nations  have  seen  a  fall off in  their exports, especially to China. Current Account deficits are widening   putting   a pressure on their currency fuelling   inflationary pressures. All this series of events are coinciding with Fed tapering of QE3.

Federal Reserve Tapering

On May 22nd, 2013 that the word ‘taper’ entered the lexicon of capital markets when the Federal Reserve chairman Mr. Bernanke first broached the possibility of tapering QE3 (Quantitative Easing, 3rd Tranche). Markets across the world panicked, emerging economies struggling with unsustainable current account deficits were the hardest hit. Indian rupee for instance fell from Rs. 54 to the dollar to nearly Rs. 68 against the dollar. This negatively impacted equity and bond markets as foreign investors with ETF allocations fled.  Bond markets saw the sharpest outflows. The panic reaction from markets sobered the Fed. The Fed in its wisdom in a surprise move, decided to postpone the taper in September, without outlining a time frame. Consequently markets rebounded and rose to touch historically highs by December across the world. It seemed  the  markets  had  forgotten  that  this  was  just  a temporary  measure.  However as the US economy continued to gather steam and a budget balancing deal was struck. Any uncertainty surrounding the fiscal and monetary framework got removed. The positive momentum of US economy prompted the Fed to announce a 10 billion dollar taper in QE 3 program in January 2014.

India’s preparedness

In May 2013,  after Fed  indicated  the  possibility   of  tapering ,  India  was in  dire  straits. The  three  pressure  points  that  emerged were the unsustainable current  account  deficit (which had risen to 4.8% of GDP);  the possibility  of  a ratings  downgrade by international credit rating agencies to junk;  and lack of adequate foreign  exchange reserves to  fight  a  speculative attack on  the rupee. The finance minister vowed to maintain the path of fiscal consolidation and bring down the fiscal deficit to below 5% of GDP. Various cuts in plan and non-plan expenditure have been instituted It was around the same time that a change of guard was happening in the RBI. The new incoming RBI governor, with the finance minister rolled out several measures to setup a bulwark against these pressure points.

RBI instituted several measures to protect the currency, these were 

·         Current Account Deficit Management

Oil and gold were the main factors   causing the ballooning deficits. Import duties on gold were hiked, and later a proportion of the quantity of imports were tied to exports. Petrol prices were decontrolled fully and diesel partially to partially pass on international prices to the domestic consumer, thereby lessening subsidies, and allowing elasticity to play a part in controlling consumption. This led to improvement in CAD as can be seen in graph 1.  In 2012-13 it stood at 4.8% of GDP but after the measures fell to 1.2% of GDP

Graph 1:  India’s Current Account Deficit as a Percentage of GDP

·         Shoring up of Forex Reserves

Limits on foreign borrowings were eased for corporate as a start, then, the RBI came out with a program to bring in dollars through the FCNR (Foreign Currency Non Resident) route. Banks were encouraged to raise hard currency deposits, and the RBI subsidized the hedging costs of these deposits at 3.5%, whereas the market prevailing rate was double that. Limits on FII investment in rupee debt were also liberalized.

·         Curtailing speculation

RBI squeezed liquidity in the domestic market to prevent easy liquidity from being leveraged to speculate on the forex markets. Short term interest rates were hike by 300% at the MSF (Marginal Standing Facility). Quantitative limits were placed on banks borrowing at the repo level. These steps stemmed the outflow of foreign currency, bolstered our own reserves, and instilled some confidence in foreigners on their India investments. The FCNR swap itself brought in 34 billion US Dollars into the country. The  danger of rating down grade too was averted by promise of continued  reduction in fiscal deficits, further  easing  of  bond  investment  limits  among  several  others . Due to these measures, and the Fed’s decision to postpone tapering, confidence in India rebounded. FII investments came in, and the rupee rebounded. Today, India’s foreign exchange reserves are comfortable. As  can  be seen in graph 2 ,   Foreign  Exchange  reserves  which  had  started  dipping  after   FED  announcement  started  bolstering  up.

Graph 2:  Indian Foreign exchange Reserves ( US  billion  dollars)

Conclusion

It seemed markets became too sanguine about having factored in the Fed tapering. Last Wednesday, when the Argentina’s currency crisis exploded and spread the contagion to other countries, the markets became jittery. The Indian rupee, in contrast stood at 62.66 against the U.S. Dollar.  The  laudatory  efforts  of  our  new  RBI  governor  to bolster the economic  defenses  against the  depreciating  currency in  2013  need  to  be  acknowledged.  It  has  been  because  of  these  efforts  that India  has  been  comparatively  less  affected till date. It  might hence be construed  and  hoped that India will not be  dramatically  affected  by  the  current  currency  crisis  enveloping   the emerging  nations.

Contributed by Prof. Sarika Rachuri (Faculty, IBS Mumbai)