A simple way to understand macro-economic growth is to imagine the national economy as one vast business conglomerate. Like any business, the Gross Domestic Product must be fuelled by Investment and consumption.

In India, both investment and consumption are largely driven by households. Household consumption accounted for 59.4% of the GDP in 2016, according to the World Bank. In comparison, government expenditure was just 11.65% of the GDP.

Total savings, which are vital for investment, amounted to 32.5% of the GDP, of which household savings alone contributed 23.6% to the GDP, according to NITI Aayog. Private companies’ savings contributed 8.5% to the GDP.

What do households invest in? A combination of physical assets such as real estate, gold, diamonds, precious metals, and financial assets such as fixed deposits, debentures, equity, Mutual Funds.

The growth potential of physical assets is less but they are also less risky. They can fuel growth to only some extent. Real estate development, for example, means construction activity and off take of cement, paint and such. A property can generate rental income, or the owner saves rent. Gold, though, is just a store of value rather than a driver of growth.

Financial investments can fuel higher growth and yield higher returns, but they are riskier. Their value can collapse dramatically and there is no tangible asset left after a crash. If a company goes bankrupt, its shares are worthless and any debt it owes may be unrecoverable. Of course, real estate can also collapse and so can gold, but there is a tangible asset left that could recover its value, or be of some residual use.

The Reserve Bank of India collects and examines household savings data, and its last two Annual Reports show household asset-allocation patterns have changed. A much larger share of household savings is now being parked in financial assets. Also, households are borrowing more.

The RBI’s Preliminary Estimates indicate that household financial savings rose to 8.1% of the Gross National Disposable Income – which is the Gross National Product plus secondary income from abroad – in 2016-’17. This followed a rise in financial savings to 7.8% in 2015-’16 and 7.2% in 2014-’15. In absolute terms, household financial savings were Rs 12,82,600 Crore in 2014-’15,
Rs 15,14,200 crore in 2015-’16 and and Rs 18,20,400 crore in 2016-’17. That is a growth of roughly 22% compounded for three years.

In the same period, while currency and Provident Fund holdings declined a little, investments in fixed deposits, insurance, and shares and debentures rose. Bank deposits rose from Rs 6,20,000 crore in 2015-’16 to Rs 10,95,700 crore in 2016-’17 while exposure to stocks and debentures rose from Rs 41,300 crore to Rs 1,82,500 crore. Alongside, household financial liabilities rose on account of increase in retail loans. The total financial liabilities of households rose from Rs 4,31,700 crore in 2015-’16 to Rs 5,74,700 crore in 2016-’17.

Safe savings?

The big jump has been in mutual funds. Indian households held Rs 9,80,000 crore in mutual funds by July 2017, a year-on-year increase of 40%. Households accounted for 48% of all mutual fund assets, 3% more than a year ago. Total fund assets under management swelled by Rs 4,80,000 crore, an increase of 31% over the previous year. This means households invested over Rs 2,80,000 crore in mutual funds between June 2016 and June 2017. Household investments in equity schemes jumped by 50% in the same period.

Most new investors were based in Class B and Class C cities, where investments in mutual funds rose by 40%. Small town investors also committed 55% of their assets to equity.

This shift to investing in financial products is perhaps a consequence of low returns on physical assets. Until 2014, the average Indian household held 77% of its total assets in real estate, 11 % in gold, 7% in durable goods such as a vehicle or inventory for a shop, and just 5% in financial assets.

But falling real estate prices led to a decline in physical savings from 12.4% of the Gross National Disposable Income in 2014-’15 to 10.7% in 2015-’16. Real estate value has declined, or stagnated. Gold prices too have been stable rather than bullish.

As real estate has declined, so have nominal interest rates on “safe” fixed bank deposits. This makes fixed deposits look less attractive even though the real return is better than it was. The real return from debt is the interest received minus the inflation rate. While fixed deposit returns have fallen from 8.5% to under 6.5% over the past three years, inflation has fallen more, from 9% to under 4%. This means that returns from debt are actually beating inflation now, but try explaining that to the average householder!

Initial returns after shifting to financial products must have been gratifying for household investors. The Nifty rose by about 14% between June 2016 and June 2017 and mid-caps returned much more than that. While mutual funds have focused on heavyweight listed companies, retail investors buying directly into equity have pushed up mid-cap and small-cap prices.

Households’ willingness to park savings in financial assets is welcome: it fuels economic growth. On the flip side, they are more exposed to scams, defaults and stock market crashes. The rising volume of non-performing assets indicates that corporate India is struggling to service debt obligations, which means corporate debt is high-risk.

If the stock market collapses or debt-ridden firms go bankrupt, the average household stands to lose a far larger chunk of savings. What’s more, higher financial liabilities will mean lower future savings because the debts must be serviced. The shift to investing in financial assets, therefore, is a double-edged sword.

Mutual funds add Rs 5.4 trillion in 2017; AUM crosses Rs 22 trillion