A big change in small town India is telling you where to make money

With potentially $500 billion per annum of financial savings arising from annual income and with potentially another $100 billion per annum arising from the balance sheet shift (from physical to financial), our visits to India’s smaller cities suggest that the annual flow into financial savings could triple over the next decade.

“We find several attributes of Indian households that are exceptional in the international context. Importantly, these distinctive features of Indian household balance sheets cannot be explained by differences in the demographic characteristics, wealth, or income of Indian households relative to their counterparts in other countries… A large fraction of the wealth of Indian households is in the form of physical assets (in particular, gold and real estate). This is unusual in the international context, and especially unusual for younger households, and for households in the bottom 40% of the wealth distribution, i.e., those with the lowest amounts of gross assets…

Over the coming decade and a half, the elderly cohort is expected to grow 75 per cent. Only a small fraction of this cohort has saved in private pension plans. Moreover, a large segment of the population of households in all age cohorts has not actively taken steps to insure adequate financial coverage during retirement. The need to finance adequate consumption during retirement is therefore a looming issue, and when combined with the low penetration of insurance, households appear particularly vulnerable to adverse shocks later in life.” – Report of the Household Finance Committee, RBI, July 2017 (Source:https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/HFCRA28D0415E2144A009112DD314ECF5C07.PDF)

Basic retirement maths…..
To become a Sebi-regulated investment advisor, one needs to pass two exams. While answering questions for the ‘financial planning for retirement’ module for the second exam, I figured out the retirement maths for a typical Indian upper middle class family.

Assume that such a family currently lives off a post-tax income of Rs 50 lakh per annum. Assume further that the income earning people in the family have 20 years to go to retirement implying that 20 years hence they will need Rs 3 crore per annum to have the same quality of life (as they do today) post-retirement.

To maintain an annual income at this level for a 25-year retirement this family will need to have in (in today’s money) a Rs 15 crore corpus.

This has devastating implications for most Indians
As we travel around India, raising assets for our portfolio, we can see in small town India, owners of SME businesses have figured out for themselves the devastating implications of the retirement maths outlined above. In particular, they have figured out their land, their property and their gold will not be enough to fund them through retirement - RBI’s remarkably well-researched August 2017 Household Financial Committee report says that 95% of Indian households’ stock of wealth is in physical assets.

As everyone in India now knows, physical assets struggle to keep up even with the rate of inflation (and therefore cannot create wealth in real terms). Unfortunately, for these SME owners (and for 99% of other Indians) very few Indian families have the wherewithal to retire with a corpus of Rs 15 crore of financial assets and, thus, adequately fund a 25-year-long upper middle class retirement.

The practical implication of this is that the smaller the town, the quicker the SME owner warms up to our offering.

So, using Tamil Nadu as an example, a pitch which takes an hour in Chennai, takes 45 minutes in Coimbatore (population: 1.6 million), 40 minutes in Tirrupur (population: 0.8 million) and around 30 minutes in Erode (population: 0.5 million). There are several reasons we believe for this pattern (which we have seen in Maharashtra as well):

> The financialisation of savings has happened to a certain extent in big cities like Mumbai, Delhi, Bangalore and Chennai. In smaller cities, most SME owners have only a smattering of financial assets (usually fixed deposits and life insurance company policies).

> The market for residential property and land still has some liquidity in the big cities – at least a few flats are being bought and sold in cities like Mumbai and Chennai. In smaller cities, the market for real estate is completely frozen solid. There have been no deals all year long in several of the smaller cities we have visited.

> The audience which meets us in the bigger cities tends to have a greater proportion of people from white collar professions – people who have a steady income and hence a greater sense of security. In the smaller cities, the audience is overwhelmingly SME owners who have to live by their wits, e.g. textile traders, spice traders, car dealers, local real estate developers.

> These people have to live with volatility in their day job and hence crave the security that comes from investing in a relatively predictable financial asset.

Investment implications
If India’s per capita income – which is around $2,000 today – grows at 5% per annum (which is what it has done in the last 10 years) over the next 10 years, the country’s per capita income will be around $3,300.

Assuming a population of 1.5 billion, this gives India a $5 trillion GDP 10 years hence. Assuming further that our household savings rate will stay at broadly 20% a decade out gives us annual household savings of $1 trillion.

At present, roughly half of household savings in India are in financial assets (the rest is in physical). If this ratio persists, then a decade out, annual household savings should be around $500 billion in India.

However, such a figure ignores the balance sheet shift that we highlighted in the opening paras of this note. As SME owners realise that they need to save more through financial rather than physical savings, they will start selling their real estate to invest in financial assets.

The question is at what rate will this shift take place? As per RBI data, currently 95% of Indian wealth is in physical assets. If this number drops by 1 per cent point per annum (which is what our reading of the Credit Suisse World Wealth Yearbook suggests) then that implies that around $100 billion per annum could get added to the annual flow into financial savings.

With potentially $500 billion of financial savings arising from annual income and with potentially another $100 billion arising from the balance sheet shift (from physical to financial), our visits to India’s smaller cities suggest that the annual flow into financial savings could triple over the next decade (from $200 billion today to $600 billion).

Over the same period, western economies and Japan will age further and their fiscal positions are likely to deteriorate further. As a result, these economies might stop exporting capital and start using their income to fund their retirements and their fiscal imbalances.

In parallel, it seems unlikely that India’s stock market and its still illiquid bond market can handle the barrage of financial flows which we are foreseeing. That, in turn, could make India a capital exporter with a per capita income of a mere $3,300 (to put things in perspective, Sri Lanka’s per capita income today is $4000). The next generation of foreign investors could, thus, be Indian fund managers looking for attractive stocks in the world outside India rather than Westerners attending conferences hosted by brokers in the five star hotels of Mumbai.

Saurabh Mukherjea is the author of “The Unusual Billionaires” and “Coffee Can Investing: the Low Risk Route to Stupendous Wealth”. He’s the Founder of Marcellus Investment Managers, a Sebi-regulated provider of Portfolio Management Services.