3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print

mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 1/6
[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed
Bonds (Part 2 of 3)
1. INVESTMENT
#1: Tight monetary policy
#2: Exports declined
#3: Policy bottlenecks
#4: investment in Valuables
2. DOMESTIC SAVINGS
3. Decline in share-debentures
4. GOLD RUSH
Why do people invest in gold?
Gold -Current Account Deficit (CAD)
How to stop gold rush?
Inflation indexed bonds
5. Mock Questions
INVESTMENT
The private sector is the major source of investment in the country.
Within the private sector there are two categories of investors
1. Private corporate sector
2. Households (aam aadmi)
From both type of investors, less investment is coming. (according to Economic
Survey). Why? There are four reasons:
#1: Tight monetary policy
Monetary policy = steps taken by RBI to control money supply.
Repo rate = RBI gives short-term loans to its clients (mostly banks) @this rate.
So when repo rate =increased= cost of borrowing increased for the banks. And
they transfer this cost by increases the final interest rate on car / home /
business loans.
Between 2010 and 2011 period, the RBI raised the repo rate by 375 basis points
(bps).
cost of borrowing increased = less people borrowing money to invest in
business.
Due to this tight monetary policy (+inflation), the Production of consumer
3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print
mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 2/6
durables declined significantly.
Because inflation is high. So a familys most income goes in buying milk, petrol,
gas, schooling, house rent, electricity etc.
Given RBIs tight monetary policy (=increasing repo rate), so home/car loan
EMI and interest rates also increased.= bike/car purchases decreased.
#2: Exports declined
In the first world countries (US, UK etc.) the impact of recession is still present.
So their consumers have less money to spend (compared to previous years.)
therefore, demand of indian products in internation market = decreased.
This is second reason for lower private investment. (if businessman is not
getting export-demand, then he has no rason to invest more money in expanding
his operation, buying new warehouse, factories, machinaries etc.)
The World Economic Outlook (WEO) Update released by the IMF, says Indias
trading partners (US/EU etc.) are growing at low rate, hence Indian exports also
declined
#3: Policy bottlenecks
Business projects worth thousands of crores are delayed because
Environmental clearance
Land acquisition, farmers agitations.
municipal permission
supply of raw materials
Because of ^these, large number of projects are stalled / pending file approvals
especially in the projects related to electricity, roads, telecommunication
services, steel, real estate, and mining.
This reduces IIP.
This also discourages new investment. = less incoming dollars = rupee weakens
indirectly.
This also increases non-performing assets (NPAs). Particularly in textiles,
chemicals, iron and steel, food processing, construction, and
telecommunications.
#4: investment in Valuables
Due to inflation, sharemarket volatility = nowadays, people invest in valuables.
Valuables = Paintings, precious metals, gold, diamond, silver and jewellery
carved out of such metals and stones.
These are called non-productive investment. (because it just stays in your bank
locker / home locker. Money should remain in circulation : from aam-aadmi to
bank to businessmen/loans.)
So, Overall investment is slowed down because nowadays people are investing in
such non-productive investment: mostly in gold.
3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print
mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 3/6
DOMESTIC SAVINGS
Domestic savings, come from three sources
1. Households
2. private corporate sector
3. public sector.
Savings Rate
Savings rate = Gross domestic savings divided by GDP @Market price.
If we look at the savings rate,
Era Domestic Savings rate %
80 and 90s 18-23%
Since 2004 onwards >30%
Household (aam-aadmi)s savings can be subdivided into
1.Financial savings 2.Physical assets
1. bank deposits (most of the money saved here)
2. life insurance funds
3. pension and provident funds
4. shares and debentures
Building, Farmhouse etc.
Usually, most of the household savings go into bank deposits. And Pension
provides funds dont get much. However, there has been some upward movement
in the share of pension and provident funds during 2008-9 and 2009-10. Why?
Because 6
th
Pay Commission implementation = disposable income of
government servants increased. And theyre the significant contributors to these
pension / provident funds
Decline in share-debentures
If you look at the data, you can see a trend: Household savings going into sharemarket
Era (approx.)
80s 8%
90s 13%
2000s 5%
So why did it increase in 90s and then suddenly declined?
3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print
mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 4/6
Because in 90s, the sharemarket was less volatile (=it did not go up and down
very frequently). And if you invested money, you could get around 20% return
on it, per year.
Fastforward to 2000s: now share market is very volatile and you get barely 10%
return on investment= not good.
Thus a combination of lower returns + higher volatility= less savings going into
sharemarket.
Implication?
When you combine above phenomenon with inflation = it is not very attractive to
invest in share market.
+ bank deposits not giving enough returns.
So people fall back to the safe investment = gold.
Gold Rush
Demand for gold has been rising worldwide
gold prices in international market are calculated in US$. And these gold prices
have doubled since 2008.
India has traditionally been a major absorber of world gold.
Gold has been a combination of investment tool and status symbol in India
Gold imports are positively correlated with inflation. (meaning, if inflation
increases then gold imports will definitely increase.)
Why do people invest in gold?
1. Share market is volatile (fluctuates a lot). And it doesnt offer attractive return at
the moment.
2. To invest in share market / mutual funds, you need PAN CARD + DEMAT
Account. Many people still dont have it. = With limited access to financial
instruments, financial markets, especially in the rural areas.
3. Rural people dont have awareness about Mutual funds, pension-provident funds
etc.
4. Inflation is high. So the profit (return) offered on back savings, fixed deposits,
pension-insurance funds = not attractive.
5. When you combine these factors: most people prefer to invest in gold / silver.
Thus, rising demand for gold is only a symptom of more fundamental problems in
the economy (inflation, lack of financial awareness etc.)
Anyways, whats the big deal? let the people invest in gold, after all its their
money!
The big deal is, if people had invested money in banking / finance sector, then
that money could be given to some needy businessmen, hell open / expand his
3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print
mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 5/6
factory = more employment + more production =good for economy.
But if people just purchase gold/ silver = that money stops moving. It just sits in
their locker = bad for economy.
Another problem => gold rush = high CAD.
Gold -Current Account Deficit (CAD)
High CAD = bad, because it weakens the rupee.
There are two main villains responsible for Indias current account deficit: 1)
gold import 2) crude oil import.
Given the energy requirements, we cannot stop / reduce the crude oil import,
else itll badly affect economy.
Then solution is obviously: reduce gold import. But how?
How to stop gold rush?
One solution = increase duty on gold import. But problem= people will start
smuggling. Then Government will not get any import duty at all.
Therefore, Economy survey suggests following things
1. Underlying motive for gold rush = high inflation. So first, Government should
curb the inflation.
2. Second problem is lack of financial instruments available to the average citizen,
especially in the rural areas. (they dont have PAN card, DEMAT account or
knowledge of how to invest in sharemarket/ mutual funds etc.). So Government
should take initiatives to increase the financial awareness, financial inclusion.
3. Government should introduce inflation indexed bonds. (then it is more attractive
to invest in bonds, otherwise 9% return is not good, if there is 11% inflation!)
Inflation indexed bonds
Normal bonds work in this fashion: 10%, 2017
Meaning you give me Rs.100 right now. Ill pay you Rs.10 as interest every year
until 2017 and then Ill return the principle (Rs.100).
Ok but what if there get so high inflation in 2017 that even cheapest ballpoint
pen costs Rs.500! Then getting back the Rs.100 principle hardly benefits you.
Because of this reason, nowadays people prefer to invest in gold rather than in
shares/ bonds/ mutual funds etc.
But in inflation indexed bonds, the principle is linked with Inflation index. So,
if from 2013 to 2017, inflation increased by 30% then you get 30% more
principle (=100 original + 30) =Rs.130. this is good because your investment is
protected from inflation.
Mock Questions
3/16/13 Mrunal [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Print
mrunal.org/2013/03/economic-survey-ch1-investment-savings-gold-rush-reasons-inflation-indexed-bonds.html/print/ 6/6
Q1. Correct statement about Indian economy?
a. Gold imports are negatively correlated with inflation
b. Gold imports are inversely correlated with inflation
c. Gold imports are positively correlated with inflation
d. Gold imports are not correlated with inflation.
Q2. Which of the following is/are responsible for excessive gold consumption in
India?
1. Inflation.
2. Lack of access or awareness about financial markets.
3. High Volatility in share market.
4. High rate of returns on investment in share market.
Choice
a. Only 1 and 2
b. Only 1, 2 and 3
c. Only 1, 2 and 4
d. All of above.
Q3. The Economic Survey suggested that Inflation indexed bonds should be introduced
in India. What will be the primary benefit of such bonds?
a. Itll help curbing the fiscal deficit.
b. Itll help reducing the NPAs of public sector banks.
c. Itll help decreasing the excessive gold consumption.
d. None of above.
Q4. Incorrect statements about savings in India?
a. It comes from three sources: households, private corporate sector and public
sector.
b. Savings rate has been above 30% in recent years.
c. bank deposits, life insurance funds, pension and provident funds, shares and
debentures are examples of physical savings.
d. None of above.
URL to article: http://mrunal.org/2013/03/economic-survey-ch1-investment-
savings-gold-rush-reasons-inflation-indexed-bonds.html