May impact financial savings, investment and growth; Policy rates likely to be unchanged for now

High inflation and the consequent low real rate of return on financial assets may force savers to take excessive risks in their search for better returns, cautioned the Reserve Bank of India.

In its 9th Financial Stability Report, the RBI said low domestic growth and high inflation continue to have an adverse effect on the savings-investment dynamics.

While households’ financial savings (which includes bank deposits) as a percentage of the GDP have been falling, expenditure on valuables (which includes gold) has risen over the last few years though it declined in 2013-14.

Households’ financial savings as a percentage of the GDP declined from about 12 per cent in 2007-08 to about 7 per cent in 2013-14. Expenditure on valuables has risen from about 7 per cent to about 10 per cent.

“This trend reflects financial disintermediation, with households switching away from financial savings to valuables, mainly gold,” the report said.

Gross capital formation dip

Further, gross capital formation (GCF) declined for the second consecutive year, in 2012-13. GCF consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories.

This decline in GCF (from about 36.2 per cent of GDP in 2011-12 to about 34.8 per cent in 2012-13) was led by the private corporate sector, thereby adversely impacting the growth prospects of the economy.

The growth-inflation setting in India was adverse for seven of the last eight quarters with below 5 per cent GDP growth and high CPI inflation.

Inflation in CPI, excluding the food and fuel segments, was persistent at around 8 per cent in the last quarter of 2013-14.

Impact of inflation

The RBI report said persistent high inflation can alter inflation expectations permanently and may ultimately impact financial savings, investment and growth.

What this means is that the central bank may keep its policy rates unchanged in the third bi-monthly monetary policy statement scheduled for August 5.

High inflation

The report observed that high inflation can interfere with the financial sector’s ability to allocate resources effectively as price uncertainty can alter inflation expectations, which can significantly increase risk premia in financial transactions.

“Formation of a stable government and the expectation that the new government will address supply side constraints will have a positive impact on inflationary expectation…

“In this context, the efforts to stabilise the economy need to be complemented by appropriate fiscal policy measures,” the RBI said.

Lower risks

The central bank said, going forward, that the risks the Indian economy is facing are expected to fall.

However, in comparison to the recent past, there could be some deterioration on the current account and fiscal deficit fronts.

The RBI opined that a fine balance needs to be struck between containing the fiscal deficit and making investments in infrastructure to boost growth.

(This article was published on June 26, 2014)
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