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[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Mrunal

[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3)
INVESTMENT
#1: Tight monetary policy
#2: Exports declined
#3: Policy bottlenecks
#4: investment in Valuables
DOMESTIC SAVINGS
Decline in share-debentures
GOLD RUSH
Why do people invest in gold?
Gold -Current Account Deficit (CAD)
How to stop gold rush?
Inflation indexed bonds
Mock Questions

INVESTMENT
The private sector is the major source of investment in the country.
Within the private sector there are two categories of investors
1. Private corporate sector
2. Households (aam aadmi)
From both type of investors, less investment is coming. (according to Economic Survey). Why? There are four reasons:

#1: Tight monetary policy

Monetary policy = steps taken by RBI to control money supply.
Repo rate = RBI gives short-term loans to its clients (mostly banks) @this rate.
So when repo rate =increased= cost of borrowing increased for the banks. And they transfer this cost by increases the final
interest rate on car / home / business loans.
Between 2010 and 2011 period, the RBI raised the repo rate by 375 basis points (bps).
cost of borrowing increased = less people borrowing money to invest in business.
Due to this tight monetary policy (+inflation), the Production of consumer durables declined significantly.
Because inflation is high. So a familys most income goes in buying milk, petrol, gas, schooling, house rent, electricity etc.
Given RBIs tight monetary policy (=increasing repo rate), so home/car loan EMI and interest rates also increased.= bike/car
purchases decreased.

#2: Exports declined

In the first world countries (US, UK etc.) the impact of recession is still present. So their consumers have less money to spend
(compared to previous years.) therefore, demand of indian products in internation market = decreased.
This is second reason for lower private investment. (if businessman is not getting export-demand, then he has no rason to invest
more money in expanding his operation, buying new warehouse, factories, machinaries etc.)
The World Economic Outlook (WEO) Update released by the IMF, says Indias trading partners (US/EU etc.) are growing at
low rate, hence Indian exports also declined

#3: Policy bottlenecks

Business projects worth thousands of crores are delayed because
Environmental clearance
Land acquisition, farmers agitations.
municipal permission
supply of raw materials
Because of ^these, large number of projects are stalled / pending file approvals especially in the projects related to electricity,
roads, telecommunication services, steel, real estate, and mining.
This reduces IIP.
This also discourages new investment. = less incoming dollars = rupee weakens indirectly.
This also increases non-performing assets (NPAs). Particularly in textiles, chemicals, iron and steel, food processing,
construction, and telecommunications.

#4: investment in Valuables

Due to inflation, sharemarket volatility = nowadays, people invest in valuables.
Valuables = Paintings, precious metals, gold, diamond, silver and jewellery carved out of such metals and stones.
These are called non-productive investment. (because it just stays in your bank locker / home locker. Money should remain in
circulation : from aam-aadmi to bank to businessmen/loans.)
So, Overall investment is slowed down because nowadays people are investing in such non-productive investment: mostly in
gold.
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gold.

DOMESTIC SAVINGS
Domestic savings, come from three sources
1. Households
2. private corporate sector
3. public sector.
Savings Rate
Savings rate = Gross domestic savings divided by GDP @Market price.
If we look at the savings rate,
Era

Domestic Savings rate %

80 and 90s

18-23%

Since 2004 onwards >30%

Household (aam-aadmi)s savings can be subdivided into

1.Financial savings
1.
2.
3.
4.

2.Physical assets

bank deposits (most of the money saved here)

life insurance funds
Building, Farmhouse etc.
pension and provident funds
shares and debentures
Usually, most of the household savings go into bank deposits. And Pension provides funds dont get much. However, there
has been some upward movement in the share of pension and provident funds during 2008-9 and 2009-10. Why?
Because 6th Pay Commission implementation = disposable income of government servants increased. And theyre the
significant contributors to these pension / provident funds

Decline in share-debentures
If you look at the data, you can see a trend: Household savings going into sharemarket
Era

(approx.)

80s

8%

90s

13%

2000s 5%
So why did it increase in 90s and then suddenly declined?
Because in 90s, the sharemarket was less volatile (=it did not go up and down very frequently). And if you invested money, you
could get around 20% return on it, per year.
Fastforward to 2000s: now share market is very volatile and you get barely 10% return on investment= not good.
Thus a combination of lower returns + higher volatility= less savings going into sharemarket.
Implication?
When you combine above phenomenon with inflation = it is not very attractive to invest in share market.
+ bank deposits not giving enough returns.
So people fall back to the safe investment = gold.

Gold Rush
Demand for gold has been rising worldwide
gold prices in international market are calculated in US$. And these gold prices have doubled since 2008.
India has traditionally been a major absorber of world gold.
Gold has been a combination of investment tool and status symbol in India
Gold imports are positively correlated with inflation. (meaning, if inflation increases then gold imports will definitely increase.)

Why do people invest in gold?

1. Share market is volatile (fluctuates a lot). And it doesnt offer attractive return at the moment.
2. To invest in share market / mutual funds, you need PAN CARD + DEMAT Account. Many people still dont have it. = With
limited access to financial instruments, financial markets, especially in the rural areas.
3. Rural people dont have awareness about Mutual funds, pension-provident funds etc.
4. Inflation is high. So the profit (return) offered on back savings, fixed deposits, pension-insurance funds = not attractive.
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4. Inflation is high. So the profit (return) offered on back savings, fixed deposits, pension-insurance funds = not attractive.
5. When you combine these factors: most people prefer to invest in gold / silver.
Thus, rising demand for gold is only a symptom of more fundamental problems in the economy (inflation, lack of financial
awareness etc.)
Anyways, whats the big deal? let the people invest in gold, after all its their money!
The big deal is, if people had invested money in banking / finance sector, then that money could be given to some needy
businessmen, hell open / expand his factory = more employment + more production =good for economy.
But if people just purchase gold/ silver = that money stops moving. It just sits in their locker = bad for economy.
Another problem => gold rush = high CAD.

Gold -Current Account Deficit (CAD)

High CAD = bad, because it weakens the rupee.
There are two main villains responsible for Indias current account deficit: 1) gold import 2) crude oil import.
Given the energy requirements, we cannot stop / reduce the crude oil import, else itll badly affect economy.
Then solution is obviously: reduce gold import. But how?

How to stop gold rush?

One solution = increase duty on gold import. But problem= people will start smuggling. Then Government will not get any
import duty at all.
Therefore, Economy survey suggests following things
1. Underlying motive for gold rush = high inflation. So first, Government should curb the inflation.
2. Second problem is lack of financial instruments available to the average citizen, especially in the rural areas. (they dont have
PAN card, DEMAT account or knowledge of how to invest in sharemarket/ mutual funds etc.). So Government should take
initiatives to increase the financial awareness, financial inclusion.
3. Government should introduce inflation indexed bonds. (then it is more attractive to invest in bonds, otherwise 9% return is not
good, if there is 11% inflation!)

Inflation indexed bonds

Normal bonds work in this fashion: 10%, 2017
Meaning you give me Rs.100 right now. Ill pay you Rs.10 as interest every year until 2017 and then Ill return the principle
(Rs.100).
Ok but what if there get so high inflation in 2017 that even cheapest ballpoint pen costs Rs.500! Then getting back the Rs.100
principle hardly benefits you. Because of this reason, nowadays people prefer to invest in gold rather than in shares/ bonds/
mutual funds etc.
But in inflation indexed bonds, the principle is linked with Inflation index. So, if from 2013 to 2017, inflation increased by
30% then you get 30% more principle (=100 original + 30) =Rs.130. this is good because your investment is protected from
inflation.

Mock Questions
Q1. Correct statement about Indian economy?
a.
b.
c.
d.

Gold imports are negatively correlated with inflation

Gold imports are inversely correlated with inflation
Gold imports are positively correlated with inflation
Gold imports are not correlated with inflation.

Q2. Which of the following is/are responsible for excessive gold consumption in India?
1.
2.
3.
4.

Inflation.
Lack of access or awareness about financial markets.
High Volatility in share market.
High rate of returns on investment in share market.

Choice
a.
b.
c.
d.

Only 1 and 2
Only 1, 2 and 3
Only 1, 2 and 4
All of above.

Q3. The Economic Survey suggested that Inflation indexed bonds should be introduced in India. What will be the primary benefit of
such bonds?
a. Itll help curbing the fiscal deficit.
b. Itll help reducing the NPAs of public sector banks.
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Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Mrunal

b. Itll help reducing the[Economic
NPAs ofSurvey
publicCh1]
sector
banks.
c. Itll help decreasing the excessive gold consumption.
d. None of above.

Q4. Incorrect statements about savings in India?

a.
b.
c.
d.

It comes from three sources: households, private corporate sector and public sector.
Savings rate has been above 30% in recent years.
bank deposits, life insurance funds, pension and provident funds, shares and debentures are examples of physical savings.
None of above.
Previous Posts
[Economic Survey Ch2] Demographic Dividend, Employment, Labour reforms, gist of
[Economic Survey Ch1] Introduction, GDP FC MC relation (part 1 of 3)
[Economic Survey Ch1] Agriculture challanges, tax to GDP, steps by Government (part 3 of 3)
[Economy] Rangarajan Gas Pricing, Production Sharing Contract (PSC), APM, Non-APM, issues, recommendations
[Economy] EPFO: Compulsory UID, Investment in AAA Corporate bonds, Air India
[Economy] Geographical Indication GI-tag: Features, Issues, benefits, Madurai
Malli, Meerut scissors
[Economy] Banking Ombudsman: Meaning, functions, appointment, reforms
explained
[Economy] Dedicated Freight Corridors (DFC), High Speed Rail Corridors, Rail Tariff
Regulatory Authority, Issues, Reforms in Indian Railways
[Economy] Banking Business Correspondents Agents (BCA): Meaning, functions,
Financial Inclusion, Swabhimaan, Common Service Centres (CSC)
[Economy] Sugar Pricing and Decontrol, Rangarajan Committee, FRP vs SAP
meaning, issues, explained

29 comments to [Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds
(Part 2 of 3)

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k k verma
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c
b
c
c

Paru
Reply to this comment
1.c
2.b
3.c
4.c

alok
Reply to this comment
1c
2b
3c
4b

alok
Reply to this comment
sorry 4 c

Manu
Reply to this comment
1C
2B

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[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Mrunal

2B
3C
4C

sami
Reply to this comment
1C
2B
3C
4C

satish
Reply to this comment
1.c
2.b
3.c
4.c

aparajita
Reply to this comment
1.c
2.b.
3.c
4.c

srk
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I am getting addicted to your explanationsIt has also came at a gr8 time when i was getting bored with the yearbook..

Arun
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The CAD in India is high due to import of not only petroleum and gold, but also due to huge import of coal(energy security), pulses and
edible oil(essential commodities)
and Gold imports constituted around 35 per cent of CAD (difference between exports of goods, services and total imports) in FY12

Prateek
Reply to this comment
Thumbs up Sirji, u are a Messiah for us, thank u so much sir, we are indebted to u.

Narayan Gupta
Reply to this comment
hats off to uou sir.could please tell that if a person invests in index inflation bond,then in this case he will be eligible for geting extra tax
benefits.i mean in terms of investment limit.

pavan kanvas
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what id index inflation bond?can u explain with a exxample?

anuraag
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sir plz give a study plan for eco survey just lyk yrbuk

Sowmya
Reply to this comment
Thank you so much its a great help.u r a saviour of people like me with zero economics backgroundthanks again

chandu
Reply to this comment
very well explainded.sir, are you going to explain all chapters in economic survey.

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[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Mrunal

very well explainded.sir, are you going to explain all chapters in economic survey.

pavan kanvas
Reply to this comment
can any one elaborate Savings rate = Gross domestic savings divided by GDP @Market price.

Shivam
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I treat your articles as a benchmark for my GS preparation :)
Good work done Mrunal

Prakash Ayappan
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Really nice explanations. I have two questions for you.
1. What will be the interest rates for the inflation linked bonds?
2. If the inflation is reduced, instead of increase, what will happen to the principle at the time of maturity?

rituraj singh
Reply to this comment
thanx a ton.this is the bestno one is anywhere near to mrunal wrt his presentation; simplification of concept and above all one just
reads ur articles and it goes straight into head.keep going

rituraj singh
Reply to this comment
pl confirm if ur going for entire ES in this wayif yes then i m pretty sure ES will be a cake walk without any extra burden on me. thanx

vivek mishra
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where would the money mopped from these bonds be invested and how will the government pay the interest amount on these bonds. Also
on the rbi mentions that there would be a provision in which if the base year for the wpi is changed, the interest would be calculated as per
new wpi. As these bonds would be for 10/12 years can there be a scenario in which due to high inflation and interest liabilities govt may
arbitrarily change the base year.

RAKESH
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What is the difference between Physical savings and financial savings..?
your 4th question is bit ambiguous.?

Prashant
Reply to this comment
cbcc

keerthi
Reply to this comment
Financial savings in the household sector comprise savings in the form of currency, net deposits, shares and debentures, net claims on
government, life insurance funds and PFs and pension funds.
Savings in physical assets consist of net addition to physical assets of the household, comprising investment in construction, machinery
and equipment and change in stocks.

B CHANDRAMOHAN
Reply to this comment
VERY NICELY EXPLAINED

chetan
Reply to this comment
c
b

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b
c
c

[Economic Survey Ch1] Investment, Savings, Gold Rush, Inflation Indexed Bonds (Part 2 of 3) Mrunal

krishna
Reply to this comment
Notification Civil Services (P) Exam 2013..plz see

Haribabu
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Nice work .keep rocking
Easy accessible the message:)

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