In June 2022, when Dalal Street witnessed a significant bear-run as stock market indices – Sensex and Nifty – reached their 52-week lows and foreign portfolio investors continued their selling spree, Finance Minister Nirmala Sitharaman dubbed India’s retail investors as ‘shock absorbers.’
In the Data Point published on December 29, 2022, The Hindu explained how retail investors played an important role in counterbalancing foreign outflows. A closer look at asset ownership on a household level shows that while their share in instruments such as mutual funds and equities is rising, it still accounts for only 8% of all households’ total 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 preferable instrument. As of FY22, households parked 27% of their assets in deposits followed by provident, pension funds and life insurance funds (chart 1). Investments which include mutual funds and equities comprised 8.9% of their financial assets. Chart 1 shows the share of instruments in total financial assets as of FY22.
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While bank deposits occupy a major share in the ownership mix, their share has undergone a significant decline. From 34.3% in 2018-19, the share of bank deposits in asset ownership came down to 25.5% in 2021-22. Simultaneously, the share of mutual funds and equities in households’ financial asset allocation surged to 8% by FY22 ( chart 2). The chart shows the share of bank deposits, equities and mutual funds in total financial assets.
Cashing the bull rally
This shift in asset ownership can be attributed to the bull rally of 2020 and 2021. In the past 10 years, annual returns of BSE Sensex showed bouts of high returns followed by an immediate fall. However, the rally that started in 2020 strengthened in 2021, luring households to move away from deposits. Following weak corporate earnings and trade tensions between the U.S. and China in 2019, bourses rebounded on the back of strong FPI flows and the easing of COVID-induced lockdowns in 2020. The reopening of the economy, and recovery in auto sales boosted Sensex’s gains in 2021.
BSE Sensex delivered 15.6% and 21.7% returns in 2020 and 2021, respectively, while the SBI’s term deposit rates for one year or more hovered around 5%. The deposit rates (as of December 31 for each year) had been on a downward trend since 2019 and by 2021, they touched 5%. Chart 3 shows annual returns from BSE Sensex and the SBI’s term deposit rates for a duration of one year or more.
In 2022, deposit rates increased on the back of hikes 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 hikes repo rate in order to flush out excess liquidity from the financial system and to curtail spiralling inflation. The deposit rate and lending rate are intrinsically linked to the repo rate. A rise in repo rate by the central bank results in a rise in lending and deposit rates. This makes borrowing costlier and benefits the depositors.
In the past eight months, the RBI has raised the repo rate on five instances. While the deposit rate has also considerably increased during the same period, it hasn’t caught up with the benchmark policy rate ( chart 4), largely because of the relative rigidity in changes in deposit rates as banks want to protect their net interest margins (as an article in the RBI’s March 2020 bulletin points out).
Source: RBI, BSE, CRISIL, CMIE and SBI