Not saving enough in financial assets? Don't blame gold!

It’s an inescapable fact that Indians love gold. But don’t blame that infatuation for everything that is going wrong with the economy.

Yes, gross domestic savings have been moderating in India, mainly driven by a fall in financial savings.But is that because they are buying more gold? Espirito Santo, in its latest report says not necessarily.

People are shying away from saving in financial assets not because they are busy hoovering gold but because policies are not conducive for investing in financial assets.

Domestic savings in India have grown from 10 percent in the 1950s to around 37 percent in 2008. That surge in savings was primarily funnelled into investments, and was responsible for the high investment and growth rates in India until then.

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But, the savings rate is moderating now, although it remained above 30 percent in 2011.The moderation is primarily driven by household savings. Clearly, under household savings, the decline in savings in financial assets, like debentures, bonds, bank deposits, is clearly visible (see chart below).

Gross domestic savings consists of three main components: corporate savings, government savings and household savings. The government has, of course, not contributed much since it is saddled by a high deficit.

So the question is, why have savings in financial assets slumped? The first reason is, of course, there have been heavy investments in gold, especially in a high-inflation scenario. Typically, gold is viewed as a hedge against inflation and a safe haven asset.

But there are two other factors that could have been important. One, the lack of appeal of financial assets and two, an increase in other forms of physical savings.

During 2009-11, disposable incomes for households grew by 13 percent. In contrast, bank deposits climbed by just 5.4 percent. In addition, provident and pension fund savings contracted by 17 percent in 2011 alone. That is because of the negative real interest rates offered by banks (Nominal interest rate - Inflation rate = Real interest rate).

That unfavourable policies and other uncertainties have pushed households away from long-term assets is clear in the fact that the percentage of household financial assets going into shares and debentures has come down from 6 percent in 2006 to an astonishing zero percent in 2011.

Insurance premiums have come down after regulatory changes. Pension scheme sales have been low due to no clear pension policies from the government. With the abolition of entry loads, mutual funds have also lost their incentive and witnessed heavy outflows since 2010.

In such a situation, Espirito Santo points out, Indian households have been holding cash, buying physical assets and gold. Currency as a part of financial assets, which basically refers to cash held by households, has grown from 6 percent in 2001 to 13 percent in 2011. Households have also invested in physical assets like houses. But they don’t fully explain the drop in savings.

Have Indians invested in gold? Yes, but gold and gold import volumes saw a correction in 2011, although by value, imports were higher because of spiralling prices. India’s demand for gold jewellery dipped by 14 percent in 2011 from a year ago, although there was a marginal 5 percent increase in gold bar and coin investments.

However, when calculating a country’s accounts, gold is not considered as a part of savings; instead, it is viewed as consumption.

That means the ratio of gross domestic savings (GDS) to GDP has fallen, even without accounting for gold. In other words, gold cannot be held responsible for the lower rate of savings.

Moreover, as the brokerage notes, curbing gold imports will not necessarily lead to more savings in financial assets. Addressing regulatory and policy challenges will be essential for households to put more money into financial assets. When the outlook for financial assets improves, households will automatically up their investments in such assets. But not before.