>Structural Liquidity Story Intact (MORGAN STANLEY)

• Key Debate: The latest savings data shows that savings into equities dropped sharply in F2009. Is this a sign of dwindling risk appetite among Indian households and does this challenge the longer-term story for equity savings?

• Structural liquidity story unchanged: India’s structural liquidity story is intact and being reinforced with the passage of time, in our view. We expect savings into equities over the next 10 years to accumulate nearly six-fold over the previous decade’s total to US$300 billion at the current exchange rate. The structural liquidity story is being driven by falling age dependency, lower risk averseness that is typical of a younger population, and a progressive financial economy. We are assuming that India receives adequate policy response in the form of infrastructure spending, health and education spending and a benign social environment. Our simple model assumes an 11.5% nominal GDP growth rate, a linear rise in financial savings, and a growing share of equity savings in the financial savings pool.

• Our model simple and likely conservative: Our model assumes annual growth of 11.5% in nominal GDP (8% real and 3.5% deflator), a linear rise in financial savings to GDP by 25bp annually (supported by demographics), a 50bp annual increase in the share of equities in financial savings (backed by demographics) and positive equity returns. This model suggests that flows into equities from Indian households could aggregate Rs14545 billion or US$300 billion (at the current exchange rate) over the next 10 years until F2020. At about 25% of India’s present market cap, this compares with 25% of current market cap that Indian households own in equities (either directly and through mutual funds) and with US$52 billion that Indian households have saved in equities over the past 10 years (at current exchange rate). At the end of the 10-year period, household savings in equities would be 10% of gross financial savings, on our assumptions, compared with its 39-year average of 5.8%.

• F2009 was an aberration in the long-term story for equities: Despite the fall in savings into equities during F2009, we think that India’s structural liquidity story is intact, albeit with near-term challenges. Note the following points:

• The elevated base of F2008 (when equity savings share in household savings hit a 17-year high of 13%) aggravated the fall in equity savings, which suffered its worst drop since F1971 (earliest data point).

• Households continue to be grossly underexposed to equities. At cost, equity investments are well off the mid-1990s peak and at just 6% of total household assets. Deposits have gained share in the balance sheet, accounting for a substantial 56% of total assets at cost.

• Trailing returns matter to household investors – they are more likely to invest in equities when equities are rising rather than falling. So enthusiasm for equities will only return when households are convinced that equity returns are likely to be strong, which may take some time
post the 2008 debacle in the stock market. In our essay entitled, Equities in the Coming Decade: Gold Class, dated January 21, 2010, we pointed out that equities are likely to be best asset class in the coming decade. This, in turn, will help the structural liquidity story.

• Real rates remain low, and that is a challenge for financial savings to rise. Households have preferred physical assets over financial assets in low real rate environments. Hence a turnaround in equity savings is unlikely in the near term but quite plausible over the next several months as real rates rise from their current low levels.

To read the full report: STRUCTURAL LIQUIDITY