Mr. Abhishek Dubey, Head - Strategic Business Development Unit
Abhishek Dubey is the Head of Strategic Business Development Unit and part of NJ since last 10 years. Abhishek has played a key role in building the policy, process & system structures at NJ. He is the Chief Policy & Communications officer and also responsible for publications and the front-end - websites & on-line desks at NJ.
A lot has been talked about demonetisation over the past 50 days. Virtually every person has an opinion and his own economic analysis on the same. This piece however spares you from another economic commentary and instead just focuses on one thing which we all are really concerned about – financial savings.
Many of us presumptuously feel that that financial savings, including mutual fund investments, will increase going forward. But many amongst us would also be at odds to explain the reasons for same, from where the money would come and what is the size of the potential opportunity in front of us? To answer these questions, we need to step back and look closely at the bigger picture. We can see that many different streams of seemingly independently working factors will increasingly deepen the flow of money towards financial savings. Broadly, these can be classified into two main streams.
1. Movements /adjustments within financial assets
2. New inflows into financial assets from black economy
A] Movements within Financial Assets:
1. Currency Holdings:
Demonetisation has clearly hurt something which we Indians love – cash. I would love to share an interesting insight – cash holdings of Indians (as percentage of financial assets of households) has been rising steadily over past few years while on the other hand the bank deposits have fallen more alarmingly. Today the currency share stands at over 13% which is over double that of entire in shares & debentures, including mutual funds at ~6%.
Having a large portion of holdings in cash is in nobody's best interests. With demonetisation, we can safely assume that a large part of earlier holdings in Rs.500 & 1000 notes, comprising of estimated 84% of all currency holdings, will stay in the banking systems for some time. Even after remonetisation, cash holdings will not rise as much as they have fallen and most probably cash holdings will not see a double digit % share ever again. This is assuming Indian's will gradually adopt digital payment modes in their day-to-day lives.
2. Bank Holdings:
Banks have been flush with cash after demonetisation. Typically, any bank prefers to hold more money in CASA (Current Account & Savings Account) as the interest liability is less there compared to term deposits. But with too much of it, sooner or later, banks have to channelise or at least manage the inflow deluge in a productive manner to ensure the it does not hurt profitability. This puts a downward pressure on all interest rates in the banking system.
Prior to demonetisation, an estimated ~18% of our financial assets were into CASA accounts and about ~23% was into term deposits. With demonetisation, the share of ~41% bank holdings will likely increase to the extend the demonetised currency is not withdrawn from banks. With higher liquidity, banks will likely lower interest rates, especially for term deposits reducing interest income for investors. Also, it is unwise to not to believe that investors will continue holding a disproportionately large portfolio in bank holdings without diversification or for better returns in market linked products.
3. Non-Cash & Bank Holdings:
As of now, 45% of financial assets are into non-cash and non-banking financial assets like life insurance funds, pension funds, shares, debentures, etc. If we remove shares & debentures at ~6%, we are left with less that ~39% approximately of financial assets having non-market linked returns.
Lower inflation levels and a secular downtrend in interest rates over the years have seen the interest rates offered by small saving schemes also falling. Government has been bold enough to bring reforms in deciding these interest rates which are now more dynamic and they no longer enjoy the protection from political generosity and sensitivity. With lower interest rates, products like pension funds, life insurance funds, etc. will also find it hard to deliver attractive post tax returns to investors. Surely, a large part of funds coming into the formal channel will make way into such products but it would be increasingly difficult to satisfy the investors with higher post tax interest rates going forward. As it looks today, the interest rates will fall and never rise again to the present rates in foreseeable future.
B] New Inflows :
1. Black Economy:
The definition of black money can be simply put as money which has been hidden from taxation. Many figures have been thrown around by many people about the size of the black economy but no one knows for sure. The shadow economy may be anything from 25-45% of the GDP which is the normal range for developing economies. As measures against black money gain traction, a good shift towards formal economy will happen and to that extend, the economic indicators including GDP will rise going forward.
To the credit of the government, demonetisation has clearly left an impression in our minds that it will be increasingly difficult to generate, store and use black money. With rising popularity and usage of digital payment modes, already business books have started getting white. With GST being set to launch from next year, businesses will be again forced to readjust and integrate with the formal economy.
Going forward, even if 5-10% of the black economy changes its colour every year, we would have a big part of our economy moving into banking and taxation channels. Guesstimates suggest that these figures can be huge and we can potentially have an additional ~0.50% of GDP being saved into financial assets every year.
2. Tax Net:
In a country of over 125 crore people, only 3.65 crore file their returns with less than 25 lakh people declaring annual income over Rs.10 lakh. Surprisingly every year over 25 lakh cars are sold in India where average holding period is about 5-7 years. The extent of tax evasion sounds astounding in India where the general mindset of any person was to first to avoid taxes.
The reasons for this can be many but today we can see the government shifty moving towards bringing more people into tax net. Today buying of anything expensive leaves behind a trail which can be pursued later by tax authorities. The Benami property legislation is one step in this direction which is set to make a big impact soon. The government is shown its intent to lower taxes, remove exemptions and bring ease in taxation matters and it can be safely assumed that this intent will only strengthen in coming days. As more and more money and people fall into tax net, it is obvious that they would seek products offering tax advantages as the avenues to hide money like real estate, gold, etc., will loose their charm.
3. Economic Growth:
The final big picture is of the economic growth of India which we all are well aware of. With big trends like contracting black economy, greater tax compliance, GST, lower inflation, lower interest rates, greater government spending and rising consumption power, we can safely assume that the economic growth will be sustained and perhaps will even reach outer orbits of 8-9% growth. The obvious impact will be on corporate profitability and continued inflows into capital markets driven by rising incomes of country with very favorable demographics. Perhaps no better script for growth of markets exists anywhere else in the world.
4. Nascent MF Industry:
In the end, lets just look at the MF industry size. A simple statistic of MF Industry AUM to GDP ratio clearly places us at the nascent stage of evolution compared to other big economies. The industry AUM comprises ~80% of the US economy and with India at ~7%, it looks like the story is yet to begin here. All the reasons that we have argued for greater financial savings, especially in market linked products, will help fill this void. Even if we target reaching half way at say 40% of GDP in say 10 years hence, the industry can potentially multiply by 11 times by what it is today!
The figures are mind boggling but are drenched in logic and probably in line with the market forces. But to ride this wave, we will have to adopt and embrace technology as never before. The change will happen but it cannot really reach its full potential until we become fully ready and geared up to take advantage of the market upheavals. Only when we are in position to reach and to service any customer without any physical boundaries, can we multiply scale and volumes. The least we can target today is 10x of our own AUM in 10 years just by staying active in the industry. But for those who believe, sky can be the limit. May the force be with you! On second thoughts, it is with you already...
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