INVESTMENT
- The private sector is the major source of investment in the country.
- Within the private sector there are two categories of investors
- Private corporate sector
- 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 familyās most income goes in buying milk, petrol, gas, schooling, house rent, electricity etc.
- Given RBIās 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 Indiaās 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 āvaluablesā.
- 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.
DOMESTIC SAVINGS
Domestic savings, come from three sources
- Households
- private corporate sector
- 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)ās savings can be subdivided into
1.Financial savings |
2.Physical assets |
|
Building, Farmhouse etc. |
- Usually, most of the household savings go into bank deposits. And Pension āprovides funds donāt 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 theyāre 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 | Ā (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 āsafeā 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?
- Share market is volatile (fluctuates a lot). And it doesnāt offer attractive return at the moment.
- To invest in share market / mutual funds, you need PAN CARD + DEMAT Account. Many people still donāt have it. = With limited access to financial instruments, financial markets, especially in the rural areas.
- Rural people donāt have awareness about Mutual funds, pension-provident funds etc.
- Inflation is high. So the profit (return) offered on back savings, fixed deposits, pension-insurance funds = not attractive.
- 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, whatās 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, heāll 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 Indiaās current account deficit: 1) gold import 2) crude oil import.
- Given the energy requirements, we cannot stop / reduce the crude oil import, else itāll 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
- Underlying motive for gold rush = high inflation. So first, Government should curb the inflation.
- Second problem is lack of financial instruments available to the average citizen, especially in the rural areas. (they donāt have PAN card, DEMAT account or knowledgeĀ of how to invest in sharemarket/ mutual funds etc.). So Government should take initiatives to increase the financial awareness, financial inclusion.
- 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 ābondsā work in this fashion: 10%, 2017
- Meaning you give me Rs.100 right now. Iāll pay you Rs.10 as interest every year until 2017 and then Iāll 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 āinflation indexed bondsā, 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?
- 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?
- Inflation.
- Lack of access or awareness about financial markets.
- High Volatility in share market.
- High rate of returns on investment in share market.
Choice
- 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?
- Itāll help curbing the fiscal deficit.
- Itāll help reducing the NPAs of public sector banks.
- Itāll help decreasing the excessive gold consumption.
- None of above.
Q4. Incorrect statements about savings in India?
- 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.
GOOD WORK
Sir
I would like you to kindly explain two topics
1. working of Exchange traded funds (ETF’s) with emphasis on underlying asset as gold
2. Some tips to study The XII Five year plan & analysis of XI FYP
Shouldn’t economic survey also suggest controlling black money as one of the ways to curb gold rush?
Yet Another good take on Index-Inflation Bonds,Inflation & Gold Rush & its reason & the curbing tactics of same in simple, lucid & pointed way.Money Should keep flowing then only an economy is stable & safe.
Thanks!!
is rise in price of gold directly proportional to inflation???…(in most probability not)…so why dis govt introduced inflation indexed bonds to reduce gold demandare intordiuced ??(.they are good otherwise as they will provide better returns…but if they are introduced just to curb gold demand than will they succeed in fulfilling their purpose??)…p.s- the question struck me when I read the ETF article (ETFs are more fruitful i guess..)..
Correction
is rise in price of gold directly proportional to inflation???ā¦(in most probability not)ā¦so why dis govt introduced inflation indexed bonds to reduce gold demand ??(.they are good otherwise as they will provide better returnsā¦but if they are introduced just to curb gold demand than will they succeed in fulfilling their purpose??)ā¦p.s- the question struck me when I read the ETF article (ETFs are more fruitful i guess..)..
c
b
c
c
In above mock questions,3rd one’s answer is i think D,because Inflation index bonds are nothing to do with Gold,they will protect us from Inflation only.Am i correct Mrunal sir,if wrong please correct me!
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sorrry its CBCC
Inflation indexed bonds increases financial savings and helps a turn around in economy and hence can we conclude they’ll reduce NPA assets?
HI sir,
Saying gold positively related to inflation ie more inflation more gold import implies that theres more money in the mkt better to say ppl have more savings to invest in gold !!! does high inflation always occur due to more money flow in the market ??
In 3rd option of 4th question , what is meant by ‘physical saving’?
what is the right answer ?
@Nik
In the article,in the table of financial savings v/s physical assets, its given that insurance,pension,provident funds etc. come under financial savings..In the question,physical savings means physical assets..
So the statement which is incorrect is (c)..Ans is (C).
@ Mrunal
Dude we are waiting for authentic ANS KEY
Sir please provide official answer key PLEASE.. I think answer to Q3 is (D) coz inflation indexed bonds are meant to overcome losses that would be caused to investors because of inflation in the years to come,how can they reduce gold consumption⦠??
Someone please help clarify this..
people buy gold as to protect their savings against inflation. Inflation indexed bonds offer them protect their savings against inflation. So if Government takes initiatives to promote such bonds, it’d divert people from buying so much gold for investment purpose.
“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.”
sir, If people buy gold from a jewellery shop, then its an spending. when more people pay the jeweler, he gets more income- he employs more people, his son will get more pocket money etc…however money circulates.
so even investing in gold is kinda spending…so how will it harm economy(apart from CAD)…please clarify sir.
thank you
Good thinking shankar, however, when u buy gold it becomes an asset and it fetches nothing in return to u nor economy. it stays in ur locker as show piece, had it been in the financial system like in the bank or shares or debentures, could have been in productive sector, thereby able to create some more money in circulation and give u some return n which can be again used for some other purposes. Seriously speaking, there is nothing harm to the economy from the social perspective. But in economic sense, yes.
c
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to ecomony survey of india is like to reach on the peak of mount everst, but u become its to easy to read. thanks
Thank U Sir
happy teachers day sir>>>>
economy was never so interesting…(double fun with improved website).