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Small mercies

Small mercies
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First Published: Tue, Sep 04 2007. 01 03 AM IST

Updated: Tue, Sep 04 2007. 01 03 AM IST
The government seems to have succeeded in weaning the average Indian investor away from small savings schemes. The Reserve Bank of India (RBI) says in its new annual report that the percentage of household financial assets invested in small savings schemes has dropped steeply—from 24.5% in FY2005 to just 5.2% in FY2007.
It wasn’t so long ago that small savings schemes such as the public provident fund (PPF) were a big hit with the average investor, because the government fixed interest rates on them that were higher than the market rates that banks paid their depositors. Many of these schemes were also tax-free, which was an additional benefit. However, the vast amounts collected under these schemes were an embarrassment of riches for the government because it had to pay above-average rates of interest on these liabilities. The fact that small savings schemes are no longer attractive is, therefore, good news for the government.
How did the government achieve this feat? By making small savings schemes less attractive. It did raise the rates of interest on these schemes while market rates of interest went up. As a result, small savings schemes are no longer attractive, compared with bank deposits.
All that the government did was change the incentives to investors, and they responded accordingly. This is a clear endorsement of the adage that people respond to incentives.
That also seems to be borne out by the data on the amount of household financial savings being invested in the equity and bond markets. Households invested 1.2% of India’s GDP in stocks and debentures last fiscal, a big jump from the 0.2% of GDP invested in these instruments two years ago. At first glance, that appears to be a sign that more and more people have been attracted by the bull run in equities in the last four years. A closer look, however, shows that most of the money has gone into the debt schemes of mutual funds, rather than into equities. That’s probably because of the rash of fixed maturity plans that have paid more than bank deposits of similar maturity. That conclusion is also borne out by the fact that more and more of investors’ money is being parked in bank fixed deposits. Households invested 10.2% of GDP in bank deposits in FY2007, almost double the 5.2% two years ago.
Given the fact that bank deposits pay around 9-9.5% per annum while the consumer price index for industrial workers is at 6.45%, bank deposits are not exactly a very lucrative investment, at least post-tax. It’s obvious that Indians continue to be extremely risk-averse. Preservation of capital, rather than the prospect of large gains, is what motivates them. Of course, lack of information is also an issue. Both risk aversion and lack of information are probably the reasons why households have invested such large amounts in unit-linked insurance plans, which often have fat commissions that are deducted from the amount invested.
The irony is that Indian investors weren’t always so risk-averse. During the early 1990s, for instance, they invested more than one-fifth of their savings in stocks and debentures and in units of the Unit Trust of India (UTI). The Harshad Mehta scam, followed in quick succession by the vanishing companies scam, the non-banking financial companies scandal and the UTI meltdown and the bear market of the early 2000s, scared them out of equities. They have thus missed the biggest rally ever seen in the Indian capital markets. The task before the mutual funds, other market players and the market regulator is to create the right environment for attracting household savings back into the market. Weaning them away from government-sponsored schemes is the first step—the challenge is to educate them to allocate a part of their portfolio to equities.
Why are Indians so risk-averse in their investments? Write to us at views@livemint.com
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First Published: Tue, Sep 04 2007. 01 03 AM IST
More Topics: Small savings | Mutual funds | PPF | Views | OurView |