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What is ailing equity savings?

Over the past 20 years, equities have delivered an average risk premium of 5.9%. The second insight is that, even though equities are a long-duration asset, households in India tend to evaluate them on one-year performance.

September 17, 2013 1:16 IST | India Infoline News Service
The secular decline in equity savings since the early 1990s is one of India’s biggest structural issues. It has crimped domestic risk capital formation, increased India’s dependence on global risk capital and, therefore, escalated stock market volatility relative to earnings volatility. What is ailing domestic equity savings?

Following is an extract from a report titled Asia Insight: India’s Structural Problem and Potential Solution, authored by Ridham Desai, Sheela Rathi and Utkarsh Khandelwal of Morgan Stanley Research:

Our insight: Our proprietary AlphaWise survey brings two important insights in the context. The first is that Indian households expect at least a 5% risk premium from equities and, on an average, the premium demanded is 9%. To us, this is steep, because we consider 6% as the fair level. Over the past 20 years, equities have delivered an average risk premium of 5.9%. The second insight is that, even though equities are a long-duration asset, households in India tend to evaluate them on one-year performance. These insights explain the challenge in reviving equity savings in India. The hurdle rate is too high and the investment horizon is too short. Unless this anchoring changes, India’s dependence on the rest of world for risk capital will continue and therefore expose its equity markets to the volatility of global capital markets.

Potential solution: Firstly, financial savings need to more attractive. Hence, real rates have to be higher. This is better achieved with lower inflation than with higher nominal rates. The latter drags down growth, whereas the former boosts savings. In order to reduce inflation expectations, public spending on consumption has to fall and, hence, public savings need to rise. Secondly, India has to lift its growth rate back to its potential – this can happen only if the investment rate rises and it follows from the first point. If these two factors were to happen, in the short term they might prove punitive for equity markets, but in the long term they could set up the case for a mega bull market in equities, backed by higher earnings and multiples.

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