That India needs $500 billion to finance its infrastructure-build is a well-known factoid, repeated endlessly in most news articles pertaining to infra financing. More specifically, as our Minister for Roads Transport, reminds us regularly that whilst the previous decade belonged to IT, this is the decade of infrastructure.
Beyond infrastructure, the other investment theme on which reams have been written is the Indian middle class and its burgeoning consumption power. These two “spending” related investment themes are so central to the ‘India story’ that another aspect of India’s success has been overlooked altogether. That story is savings or rather the composition of India’s savings. There are four overlapping trends that will combine to generate rapid growth in retail investments in the equity market and in life insurance/pensions.
One, with GDP growing at 7% per annum and population growing at 1%, my colleague, Dipankar Mitra points out that India’s per capita income (PCI) should grow at 6% per annum over the next 20 years. As a result, by 2030, India’s per capita income should hit $10,000 in real purchasing power (RPP) terms (compared to $3,000 at present).
Two, India’s savings rate has risen relentlessly over the past 30 years and is now approaching 38%. Based on our analysis of other developing and developed countries’ savings rates, we expect India’s savings rate to peak at 45% in 2030.
Three, equity investments currently account for only 5% of retail financial savings in India. As India moves towards the rich-country norm of 20%, the amount of retail money entering the stock market annually would grow a staggering nine-fold.
Finally, pensions/life insurance currently account for 30% of retail financial savings in the Western countries. Surprisingly, India has already hit this 30% ratio. However, as the overall quantum of savings rises, retail flows into life insurance/pensions will grow seven-fold.
Just in case you believe that these four trends represent mindless extrapolation, over the past 17 years, India’s savings rate has risen from 23% to 38% and the annual flow of retail money into the stock market has risen six-fold. So all we are predicting is a mild acceleration, based on data from the rich world, of what is already a well- established mega trend in India.
How to play the “savings” theme?
The market capitalisation of Indian banks, insurers and stock brokers is currently $100 billion, $20 billion and $5 billion respectively (insurers’ market cap based on analysts’ estimates). What’s interesting is that the smallest of these three groups – the stockbrokers – are ideally placed to benefit from the long-term trends highlighted above, both, as conduits through which people like you and I will access the stock market and as distributors of packaged financial products ranging from mutual funds to all varieties of insurance. Hence looking out over the next 20 years, established stock brokers are well-placed to be the best performers among financials stocks in India.
So where does that leave banks – the largest constituents of the Sensex? While we await the IPOs on Indian life insurers in CY10, we note that all of the top life insurers in India are owned by large banks. In fact, the banks’ branch-based distribution network pretty much makes them unbeatable because it helps them keep distribution expenses low relative to non-bank rivals.
However, looking beyond the life insurance IPOs, we can see life becoming more difficult for banks as competition intensifies within our financial sector and India transitions from a predominantly bank-based financial sector to a more market-based system. At its simplest, this means that as banks have to fight harder (versus stock brokers and mutual funds) for retail deposits, deposit rates could rise further thereby lowering the net interest margins of banks. This trend has already established itself as banks have lost around 100 basis points of margin between FY99-09.
However, all is not lost for the banks. The experience of rich world countries with market-based systems shows that as GDP grows, so does the credit to GDP ratio. This indicates massive upside for our banks if, and it is a significant “if”, they can grow credit from the current 15% of GDP to the rich country levels of 30%.