Negative real rates push savers to overheated stocks

Mumbai: Indian savers rarely have had to brood over eroding values of their fixed deposits unlike their Western counterparts. While interest rates in India have not been cut to the near-zero levels as in the advanced economies, the Reserve Bank of India’s latest experiment with negative real interest rates, in an attempt to jumpstart the economy, is forcing squirrels out of their burrows. Result: They are dipping their toes into shares that have hitherto been ignored by the markets — and even out-of-favour residential properties.Real rate is the return that a security earns over inflation. Currently, the safest banks offer around 5% for one-year fixed deposits, while the consumer inflation in October was at 7.6%. So, the current real rate of return — before taxes — is -2.6%, which essentially means inflation is eating away at the value of savings. Effectively, negative real rates punish cash hoarders.So how are savers reacting? The concept of real rates is alien to most small-time savers, who are oblivious of the impact of higher inflation on savings rates. That said, the sharp decline in interest rates by banks is already hurting savers — mainly the retired. The more affluent and knowledgeable are, however, churning their portfolios to include assets that would help them keep up with the price spiral.The shift is to higher risk products. For instance, October witnessed a flood of outflows from safe liquid mutual fund schemes by institutional and well-heeled investors to some other debt categories. The current annual returns from liquid schemes are 3-3.5%, which makes real returns -4-4.5%. Rich investors who parked their money in deposits and safe debt mutual funds are moving some of this money into stocks. The beneficiaries of this shift have been the battered mid- and small-cap stocks. Investors are willing to up their allocations to equities even after the record-breaking run because of the assumption that flows from global funds are unlikely to reverse for now. Some wealth managers have been asking their clients to buy shares of battered public sector companies with dividend yields of as high as 10.5% as a substitute to low-yielding fixed deposits. In short, RBI’s experiment of smoking the squirrels out is forcing money to move around. When a central bank keeps the real rates wafer-thin or in the negative zone, the intention is to push savers to spend and lift the economy out of the slump. It is too early to conclude that people are en masse breaking their deposits and spending but they are certainty looking to make their make their money work harder.The real success for the RBI will, however, be when the negative real rates manage to move the needle in the comatose real estate market. A revival of this sector is considered crucial for kickstarting activity on the ground. The experiment worked well in the US in 2008-09, when the Fed brought in negative real rates in response to the collapse of the economy following the global financial crisis.While the government has been exhorting developers to clear their inventories, wealthy investors are scouting for opportunities in the affordable housing space, which is where the opportunities are as the Work From Home (WFH) format and low interest rates are expected to attract homebuyers in far-flung suburbs. Unlike savers, borrowers benefit from negative real rates. But since these are early days, the rush is still missing.Investors, who are not keen on being early birds in the sector, are combing the stock market for opportunities linked to a rebound in real estate.The best bet on the segment would be the property developers themselves but options here are sparse with most listed companies being in the luxury market - or laden with scary amounts of debt. So, they are looking for close substitutes such as housing finance companies and segments that cater to the construction of properties despite worries about some of their health.The stock market looks overheated at current levels but unattractive interest rates continue to make equities look appealing. But it also means that the stock market could increasingly become vulnerable to inflationary pressures. That could be one of the reasons investors are now looking for a margin of safety in the equity investments rather than opting for the growth theme at any cost.For its negative real rate experiment to work, RBI would be less worried about asset-price inflation compared to real inflation.

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