In June 2022, when Dalal Street witnessed a major decline as equity indices – Sensex and Nifty – hit their 52-week lows and foreign portfolio investors continued their selling frenzy, the Minister of Finance Nirmala Sitharaman called Indian retail investors “shock absorbers”. ‘
In the Data Point published on December 29, 2022, The Hindu explained how retail investors play an important role in offsetting foreign outflows. A closer look at asset holdings at the household level shows that while their share in instruments such as mutual funds and stocks is increasing, it still represents only 8% of total household financial assets.
Indian households traditionally held their wealth in physical assets such as real estate and gold. But FY21 saw a dramatic shift towards financial assets. Within financial assets, deposits have always been the preferred instrument. As of FY22, households placed 27% of their assets in deposits, followed by provident funds, pension funds and life insurance funds (Chart 1). Investments that include mutual funds and stocks accounted for 8.9% of their financial assets. Chart 1 shows the share of instruments in total financial assets from year 22.
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While bank deposits occupy a large share in the ownership mix, their share has suffered a significant decline. From 34.3% in 2018-19, the share of bank deposits in asset holdings fell to 25.5% in 2021-22. At the same time, the share of mutual funds and stocks in household financial asset allocation jumped to 8% in FY22 ( table 2). The graph shows the share of bank deposits, stocks and mutual funds in total financial assets.
Cashing in on the bullish rally
This shift in asset ownership can be attributed to the bullish rally of 2020 and 2021. Over the past 10 years, BSE Sensex’s annual returns have shown bouts of high returns followed by an immediate drop. However, the recovery that began in 2020 strengthened in 2021, prompting households to turn away from deposits. Following weak corporate earnings and trade tensions between the United States and China in 2019, stock markets rebounded on strong REIT flows and the easing of COVID-induced lockdowns in 2020. The reopening of the economy and recovering auto sales boosted Sensex’s earnings in 2021.
BSE Sensex generated returns of 15.6% and 21.7% in 2020 and 2021, respectively, while SBI term deposit rates for one year or more hovered around 5%. Deposit rates (as of December 31 of each year) had been on a downward trend since 2019 and in 2021 they were touching 5%. Chart 3 shows annual BSE Sensex returns and SBI term deposit rates for terms of one year or more.
In 2022, deposit rates increased due to increases in the benchmark repo rate, albeit with a considerable lag. The repo rate is the rate at which the RBI lends money to commercial banks. The central bank raises the repo rate to remove excess liquidity from the financial system and curb the spiral of inflation. The deposit rate and the lending rate are intrinsically linked to the repo rate. A rise in the repo rate by the central bank leads to higher lending and deposit rates. This makes borrowing more expensive and benefits depositors.
Over the past eight months, the RBI has raised the repo rate across five instances. Although the deposit rate has also increased significantly over the same period, it has not caught up with the benchmark policy rate ( table 4), in large part because of the relative stickiness of changes in deposit rates as banks want to protect their net interest margins (as an article in the March 2020 RBI Bulletin points out).
Source: RBI, BSE, CRISIL, CMIE and SBI
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