Inflation takes it all: Why 2013 was a disappointing year for savers

‘I don’t want to talk

About things we’ve gone through

Though it’s hurting me

Now it’s history

I’ve played all my cards

And that’s what you’ve done too

Nothing more to say

No more ace to play

The winner takes it all

The loser standing small

Beside the victory

That’s her destiny’

-ABBA, the winner takes it all

2013 has been quite truly the year for the loser when it comes to the household. With inflation remaining high at over 10% for most of the year - never mind that we were told that inflation is coming under control and will come down in January- the purchasing power has been eroded considerably.

Given uncertainty in the economic environment, one would have struggled to figure out where one could have invested one’s savings. This has also been a concern voiced by the RBI Governor. Here is a look at the various options we had, and where we could be in case we stayed invested for one year.

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It is assumed for homogeneity that we got in the investment mood in December 2012 and entered at an average price for the month and then would have liked to exit at the December 2013 average.

First the stock market. While the equity market appeared to be the oasis in the otherwise parched economic environment during the year, the equity investor would not really have covered for inflation. The entry and exit points would have been the Nifty at 5,890 and 6,237 till last week, thus giving a return of 5.9%. Therefore, be wary of those advisors who said that they outperformed the market. They could not have, as Daniel Kahneman would argue, done better than the market benchmark.

If one went for the safer confines of G-Secs, which are considered to be a stable and steady form of investment, the picture is actually more distressing. This is so because the market was volatile, with interest rates coming down and then moving up after May when the G-Sec yields started rising.

The NSE Total returns index was 334.9 in December 2012 and 344.7 in December 2013, which implies an increase of just 2.9%. Quite evidently this turned out to be a risky asset that could not be relied on.

[caption id=“attachment_1257957” align=“alignright” width=“380”]  2013 has been quite truly the year for the loser when it comes to the household. PTI[/caption]

One option that has always been a safe haven has been gold. It is believed largely by analysts and households that the price of gold can only rise and will never come down. Even if it comes down, it will be temporary as it is a natural hedge against inflation as well as a safe investment. Starting from $1,684/ounce in December 2012, there has been only a downward movement almost continuously to $1,225/ounce after a year and anyone holding this metal would have lost 27.2%. In rupee terms, due to rupee depreciation, the loss would get moderated to around 19% (but still negative). Therefore, the conventional wisdom of holding on to gold would also be debunked this year.

How about crude oil? While the world economy has benefited from stable crude prices due to absence of demand and use of alternatives such as shale, the price of Brent remained virtually unchanged with a slight downward movement from $110.7 to $109.07/barrel. So, commodities would not have quite delivered the results. Farm products in the perishable area would have, going by the WPI inflation numbers, but then these are not products that can be stored and sold when the prices increased. Otherwise, tomatoes witnessed an increase of 290%, onion 142% - but this would not have worked. Even at the theoretical level we do not have futures trading in such commodities to have a hypothetical avenue for investment.

The more conservative saver rather than investor who went in for bank deposits was better off. Bank deposit rates averaged 8.75% in December 2012, which came down to 8.50% one year later, but the household would still have been happier with this high return. Tax free bonds would have been the most prudent option with a return of between 7.6-7.9% which has gone up during the year. The effective yield would be higher once adjusted for the tax benefit too. Hence, these risk-free fixed return instruments made sense depending on the investors’ time horizon.

Therefore, 2013 has definitely been a disappointing year for the saver. Fixed returns through bank deposits made most sense, even though the real return was still negative if adjusted for inflation. In this context, the RBI has come up with an interesting concept of an inflation indexed bond for retail investors where the return is 1.5% higher than the CPI inflation. Prima facie this sounds a capital idea in the current context because with inflation being 10%, an assured amount over and above this level is good. The drawbacks are the tenure and the absence of a secondary market. The latter should be permitted to actually draw out a market oriented interest rate for such a product. Otherwise, this may not really takeoff.

The issue with this bond is that it is going to compete with bank deposits where the returns are known and would be in the range of 8-9%. If inflation comes down, which it would for certain statistically speaking, since the high base effect would come into play, then the return would move downwards. Besides, any bond of duration of 10 years competes with a tax free bond, which will continue to be issued as the government simply does not have money to fund entities like HUDCO, NHB, IRFC, REC etc. And all these bonds have a secondary market. Therefore, such issuances would naturally cannibalise these inflation indexed bonds, unless tax benefits are offered.

All this means that any saver who took a one year horizon for returns would have gained little and lost a lot when invested in any financial instrument except the bank deposit and tax free bond. A longer time horizon would have worked better for those in equity or commodities with the assumption that things will improve during 2014, and that the losses will be made good. Maybe that is what makes these markets still tick.

Welcome to the New Year.

The author is Chief Economist, CARE Ratings. Views are personal.