Trends. The two Ds that changed the financial scene

One day, two events. 8/11 was a shocking and momentous day for the Indian financial landscape, marked firstly, by the unexpected announcement by the Modi-led government to demonetise old, high-denomination notes and secondly, by the surprise victory of Donald Trump — these events shook the domestic financial markets.

While Trump’s win is yet to show its widespread effects (more of this later), the tremors of demonetisation will continue over the next 1-2 quarters. True, the jury is still out on the pros and cons of demonetisation and its execution, but one cannot dismiss the way in which the exercise has altered the meaning of money and redefined the path, wealth in Indian households will take. Both the above events were true Na Bhuto, Na Bhavishyati events (what had never happened in the past and will not occur in future).

Sample this: Almost ₹12.5 lakh crore of the ₹15.44 lakh crore worth of high-denomination notes withdrawn has returned to banks as of December 10, 2016. Of this, even if one does not account for the amount that is assumed to be recovered under fake accounts and illegitimate deposits, a significant chunk will still lie as legitimate wealth that will transform into wealth in financial assets in three stages.

In Stage I, over the short term, money lying in savings deposit accounts will move into fixed deposits as investors eye a reasonable return over and above what a normal savings account offers. Yet, the lure with fixed deposits and similar asset classes will come into question, considering the uncertainty around the interest rate environment.

The rate hike by the US Fed on December 15 (and signals of more hikes through 2017) along with the RBI’s move to hold rates in December at the monetary policy review, is likely to result in a capital flight from the Indian markets that puts the direction of Indian interest rates into doubt. Moreover, in the aftermath of demonetisation, yields on Indian benchmark government bonds have already fallen and we believe that the RBI may not massively cut interest rates.

It is amid this uncertainty that Stage II could kick in. Trump’s win in the US presidential elections is relevant here as he is expected to launch an overhaul of the US economy that will aid a gradual change in the Fed’s monetary policy. Assuming interest rates drop in India in 2017, even if marginally, aided by domestic and global factors, Indian investors are likely to move away from fixed deposits and similar instruments into the capital market, in search of higher returns.

This move will be gradual as investors will first park their funds in mutual funds (this was evident even in FY16) which will at least diversify risks arising from the volatility in direct equities. Once domestic and global macro-economic headwinds ease, Stage III will commence.

In Stage III, the shift of Indian investors’ wealth into equities could also be bolstered by the government’s reforms push and improved economic fundamentals. Given that demonetisation has resulted in a surge in bank deposits, loan interest rates are likely to come down, which will, among other factors, boost credit growth.

As this gradually results in a rise in private investments, corporate profits will improve, thereby improving their earnings per share (EPS) in the long run. This could turn an additional attraction for investors to jump onto the equities bandwagon which will help financial assets gain a credible lead over physical assets.

Equities remained the most preferred asset class, at least among high networth individuals (HNIs), in FY16, even though the markets declined 4-5 per cent. There is also considerable interest among HNIs for alternative investments.

The author is CEO- Karvy Private Wealth (India and Middle East)

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