Modinomics can channel household savings to productive financial assets (Currency Corner)

As promised, the economic revival of India's ailing economy has emerged as Narendra Modi's core political strategy. The financial markets are booming with a sense of optimism and confidence injected in the financial system with the recently announced reforms on food inflation, railway tariffs and the sugar sector. The hope is that this is just the beginning of the anticipated reform cycle, and all eyes are focused on next month's budget announcements.

A natural consequence of a sustained economic revival would be that household savings would be directed from physical to financial assets. According to Deutsche Bank, a sharp decline in both domestic and global gold prices, a government committed to inflation control and vibrant equity markets should seed the transition from physical (currently at a multi-decade high of 68 percent) to financial savings. For the past two years, as the Nifty has made higher tops, we have consistently seen domestic fund selling while FIIs have been net buyers on every possible dip. The retail investor has largely remained on the sidelines since the financial crisis and the great crash of 2008. But recent data shows a trend reversal is in place. In May, we witnessed the first signs of revival in equity allocation with equity mutual funds receiving Rs.20 billion ($332 million) ? the highest in past 33 months. Deutsche Bank believes this trend will likely extended into June as well.

Further, the domestic institutional investor (DII) selling pressure is largely expected to abate although it won't turn net positive till the first half of FY 2015 according to Deutsche Bank. The pace of DII selling has slowed sharply with year to date DII selling down 38 percent versus the same period in 2013. Inflows from insurance companies remain critical, which may turn around as investors of unit-linked products (ULIPs) recognize the strength in market according to Deutsche Bank.

Gold prices are likely to suffer further as the government relaxes the import norms currently in place. Domestic gold prices have declined around 17 percent from their peak while international prices have corrected by more than 30 percent. Sooner or later, there would be another leg down in domestic gold prices. Thus, India's fixation on gold as an investment asset is likely to take a further hit. Market participants should remember that gold is an asset with no valuation metrics and provides no cash flows. With a low level of systemic risk in the financial system and global real interest rates rising following the Zero Interest Rate Policy (ZIRP) era, it is hard to make an investment thesis for the yellow metal.

Further, Deutsche Bank notes that as the government walks the path of fiscal discipline and redirects expenditure from consumption to investments, there would be a growing consensus in market expectations of real interest rates staying positive, which would galvanize the shift from physical to financial assets.

The Modi era might mean that we are at the cusp of a turnaround in financial savings. The skew in India's household savings to physical assets might have bottomed out and we may see a transition towards more productive financial assets. The latest available data shows some uptick in financial savings rising to 32.4 percent versus 31 percent in FY 2012. This is a welcome step towards a major structural change in our economy.

(25.06.2014. Vatsal Srivastava is consulting editor for currencies and commodities with IANS. The views expressed are personal. He can be reached

at [email protected])