Real asset is defined as the asset that is tangible, such as precious metals, property and so on.
Rajesh Kumar | First Published: Thu, Oct 10 2013. 06 07 PM IST | Live Mint
The sharp contraction in the trade deficit for September came as a big relief for both markets and policymakers. India has struggled for a while to contain the trade deficit and resultant volatility in the rupee. One of the factors responsible for large external deficit in the recent times was higher import of gold as Indian households showed increasing preference for real assets over financial assets. According to data published by the Reserve Bank of India (Annual Report 2012-13), the household savings in real assets increased from an average of 12% of the gross domestic product (GDP) between fiscals 2003-04 and 2007-08 to 14.3% of the GDP in the fiscal 2011-12. The investment in valuables (read gold) during the same period went up from 1.1% of the GDP to 2.7% of the GDP.
What are real assets?
Real asset is defined as the asset that is tangible, such as precious metals, housing property, agricultural and other commodities. Financial assets on the other hand are intangible assets, such as shares, bonds, fixed deposits and all kinds of derivative instruments which derive their value from contractual claims. There are a number of reasons that are accounted for higher household investment in real assets. For example, inflation in the recent years has been on the higher side which has resulted in negative real rates on the fixed-income products, while returns on equity and equity-linked products have suffered due to adverse market conditions. Therefore in order to protect their savings, households increased their allocation to real assets. However, it is important to note that even during the period 2003-04 to 2007-08, when equity markets were doing well, the allocation to physical assets at 12% of the GDP was higher than 11.2% to financial assets. Therefore, there could be other reason at play as well, such as underdeveloped and under-penetrated financial market which is not able to channelize household savings to the financial sector.
Why preference for real assets is a problem
One of the biggest problems, as highlighted by the Economic Advisory Council to the Prime Minister in the report (Economic Outlook 2013-14), is that when households buy gold, it affects financial savings and since gold is imported, the payment leaves the country. However, when households invest in financial assets, it remains in the system in the country and helps domestic capital formation. Therefore, it is important that investment of household saving in financial assets is encouraged. Evidently, the government of India and RBI is trying to boost financial savings. RBI is currently mulling a product linked with the Consumer Price Index for households. However, in the long run, it will be important to maintain lower inflation and encourage nature and scope of financial products in order to make them more attractive than real assets.