The budget has disappointed with its absence of any serious move on savings, it's time to take a sober look at the options...
06-Mar-2013 •Dhirendra Kumar
For those of us who were excitedly looking forward to the budget doing something interesting to boost individuals' savings and investments prospects, it's time to cut our losses and move ahead. All the expectations of some new measures to boost savings, specially in the context of channeling long-term savings into equity have come pretty much to nought. Even the whole business of creating some pull away from gold and to financial instruments seems to have been abandoned.
The upshot of all this is that the entire landscape of possible savings avenue presents a desolate picture. On the one hand, raging consumer inflation means that fixed-income savings offer a net real loss of value. On the other, sustained long-term gains from equities have been increasingly hard to come by over the last few years.
The one glimmer of something new in the budget was the promise of some kind of inflation-linked savings instrument. Here's what the finance minister actually said: …in consultation with RBI, I propose to introduce instruments that will protect savings from inflation, especially the savings of the poor and middle classes. These could be Inflation Indexed Bonds or Inflation Indexed National Security Certificates. The structure and tenor of the instruments will be announced in due course.
Of course, this doesn't give us any kind of a time-frame and it could be a long time before anything concrete happens. However, inflation-linked fixed-income investments are not a new or a rare idea. They have been around for a long time in various countries including the US, UK and Canada. The general structure of most such instruments is similar. The bonds' face value adjusts upwards in step with inflation. Over and above that, there is a coupon rate at which investors receive interest. For example, such a bond could be issued with a face value of Rs 1000 each at a coupon rate of two per cent.
At some periodicity, perhaps annually, the bond's face value would adjust according to an inflation index. If in a given year the inflation was 8 per cent, then the face value of the bond would adjust to Rs 1080. Interest at the coupon rate of two per cent would be paid at this new face value.
Globally, wherever inflation-linked bonds are issued, this much is practically a standard. The key issue in India is which inflation rate is used. Since these new instruments are supposed to be specially targeted at low and medium-income savers, one could justifiably assume that consumer inflation would be the measure. In recent months, there's been a lot of noise about declining wholesale inflation and the pundits have generally opined that consumer inflation will inevitably follow. Unfortunately, there is little evidence of this happening yet. Real inflation suffered by low and medium-income savers is even higher than the stated consumer inflation and it will be a travesty if these new bonds are launched with a link to wholesale price inflation.
However, as I said, beyond the prospects of these bonds, if and when they materialise, the savings scenario is unimproved in any way by the budget. The only course that the investor can follow is to trust that eventually, growth will come and equities will start look up. The long, multi-year drift at about the same level will lead to a period when equity gains will revert to mean and thus become meaningful. Fortunately, preparing one's investment portfolio for such an outcome is simple. As in most situations, one should keep only short-term money--that needed up to a year or two--in fixed income instruments. Longer term investments should gradually keep flowing into equity mutual funds, as through systematic investment plans.
Our savings prospects won't improve materially till the economy enters a better phase. Till then, it's best to follow a strategy aimed at keeping one's head above water and staying prepared for those better times.