Inflows into domestic mutual funds & long awaited revival in CAPEX: An equation worth waiting for ?
Economic growth and Investments into the economy are like “life” partners in a successful marriage. And like all successful marriages, these two also go through rocky patches and it is the ability to sustain through these times that define a successful life-long relationship. Currently we are in one of those rocky patches where India’s investment rate (Gross Fixed Capital Formation or GFCF) has been weak; decelerating significantly in recent years. (see Chart 1).
This indeed reflects a rocky patch in the relationship and it is widely believed that acceleration to the aspired GDP growth rates of 9% per annum will be possible only when investments in the economy revive.
Jaitley, at the annual general meeting of the Indian Banks' Association (IBA) in the country's financial capital, earlier on Friday said, "There are two major challenges — one is revival of private sector investment ancd the second is improving the capacity of our banking system to support growth,"
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There are many reasons for the slowdown in capital investment in the economy. For starters currently the low level of capacity utilization means that companies are in no hurry to build new capacity. Then there is the “twin balance sheet problem”. Simply put many entrepreneurs have stressed finances and weak balance sheets. In turn the banks who have lent money to them have a mounting pile of bad loans that has severely impacted the health of their balance sheets. The good news is that some of the issues holding back investments which lie in the domain of policy making have been addressed by the reform measures undertaken by the government.
But let’s move on from the rocky patch to a relationship that is in in full bloom. The Indian public’s love affair with equities and more specifically Indian equity mutual funds.The year 2017 was momentous year for mutual funds. The domestic inflow into equities via equity mutual funds and the equity component of balanced funds is approximately US$ 32bn. Ref: Chart 2
This inflow in a single year is nearly equal to the inflows during the 3 year period 2014-2016. The pace of inflows in the past few months has been particularly strong at near $3.5bn per quarter. This is a welcome development as households in India have a savings ratio of nearly 20% of GDP.
Traditionally this 20% savings ration was biased towards the favored asset class “Real estate” and Gold. With the equity exposure of Indian households at a low of 4% of household wealth and the changing attitude towards financial assets especially equity bodes well for the Indian economy on a whole.
This gradual but steady movement towards financial assets has the makings of a win-win for the country because rising equity allocations by Indian households provides the fuel for a rise in Investments. Growth requires investment and investment requires capital. This symbiotic relationship are like conjoined twins and hold the key to our inspirational growth targets
At this juncture the need for capital is even more pressing as the earlier mentioned twin balance sheet problem needs to be addressed. CY 17 has witnessed nearly $30 billion of equity issuances, up sharply compared to previous years. Equity issuance is now running well above 1% of GDP a year and could get close to matching the record issuance of new equity (as a % of GDP) in FY 2008 & FY 2010. Not all of this is primary issuance for new capex; a large share of the issuance has gone towards repairing and strengthening balance sheets, both entrepreneur and bank balance sheets. In addition the government is the prime driver of a $30bn recap of the government owned banks.
So the liquidity flowing into equities should not be seen merely as an excuse for higher prices of stocks on the premise that money is chasing stocks. The increased demand for equities due to the shift in household allocation of wealth is enabling the supply of paper from Indian companies that are using this increased availability of capital to repair and strengthen balance sheets. This repair process is the first step. Further on down this road - rising capacity utilization & the animal spirits of entrepreneurs would lead to an acceleration in the Investment cycle.
These inflows into equities and the equally large issuance of paper are but conjoined twins. They need each other. And together they could help set the stage for a robust revival in investments and enable India to achieve its aspirational growth targets.
So in a nutshell, this liquidity flowing into the equity markets is providing the fuel to repair and strengthen the balance sheets of both the entrepreneurs as well as the lenders (Banks). This in turn would enable or rather prime both the entrepreneur to engage his/her animal spirit to look at expansion (investments) and the lender (banks) to have the confidence to provide the capital. And in turn on the cost of repeating oneself. “And together they could help set the stage for a robust revival in investments and enable India to achieve its aspirational growth targets”. Disclaimer