McKinsey & Co. last week challenged a widely accepted notion of how India is going to finance a high rate of economic growth over the next couple of decades.
The conventional wisdom is for India to replicate the East Asian model of capital accumulation. The annual household-savings rate is expected to rise from its current level of about 22% of gross domestic product, thanks to a “demographic dividend,” or a growing preponderance of younger workers with fewer children to support.
McKinsey has a dramatically different opinion.
“With reduced pressure to save for children and elders, and retirement a distant prospect, India’s youthful households will tend to save less,” Jonathan Ablett and other analysts at the New York-based consulting firm noted in their study. The McKinsey researchers expect India’s household savings to plateau and then gradually decline.
That’s not the consensus view.
Between 2005 and 2025, the working-age population in India will swell by 273 million, according to the United Nations. The country’s total population will rise by 313 million.
“When the demographic bulge raises the share of working-age adults in the population, the overall propensity to save rises sharply,” Sanjeev Sanyal, a Deutsche Bank AG economist in Singapore, said in a 2005 study.
Like Japan in the 1950s and China in the 1980s, India was entering a demographic “sweet spot.” Sanyal said.
According to the McKinsey report, Indian families are already saving too much to support small businesses directly.
Compare India with South Korea. In 2005, both had an almost identical national savings-to-GDP ratio of about 33%. Yet, in Korea’s case, households accounted for just a fifth of the overall rate, compared with 69% in India.
Household thrift in India is even more pronounced than in China, a bulk of whose 50% savings rate comes from companies and the government. As organized business expands in India, more people will give up their self-funded, low-productivity occupations and move into the formal workforce.
The modern economy has recourse to bank loans and capital markets. “Greater access to capital from the financial system will reduce the amount of personal capital that entrepreneurs are obliged to tie up in their small businesses,” the McKinsey report notes. “Households will not need to saveso much.”
To be sure, the focus of the McKinsey study is on how much Indian consumers will spend, and not what they will put away. The consulting firm predicts the Indian consumer market to surpass Germany’s by 2025 to emerge as the fifth-largest in the world, after the US, Japan, China and the UK. India ranks 12th at present. As for predicting savings behavior, McKinsey researchers do agree that the task is a complex one.
“Even if the savings story plays out differently from that of our base case—for example if investment expands to a higher level than that which we have forecast—the impact on consumption is likely to be minimal,” the McKinsey analysts say.
Does it matter if Indians set aside more money or less?
Reserve Bank of India deputy governor Rakesh Mohan says it’s plausible that gross domestic savings in the year ending 31 March 2008 will rise to as much as 35% of GDP. That’s almost 10 percentage points higher than in 2003.
Add a small amount of capital absorbed through a current- account deficit, estimated to be less than 2% of GDP, and India has enough resources for economic growth of 8% or 9%. With more productive use of capital, even 10% is feasible.
The trouble with this happy picture is that when the economic cycle turns, both the growth in corporate profits and the government’s fiscal improvements may disappear, cutting off resources for economic expansion.
So does India really need savings to rise much further? No, it only needs the ratio of savings-to-GDP to become more stable. And that will require the demographic dividend tokick in.
The additional resources that have sustained the resurgence in economic growth in the past four years have largely come outside of the household sector—from company earnings and budgetary gains.
In the financial year that ended in March 2003, household savings were about 23% of GDP. The economy that year grew less than 4%. Three years later, the GDP growth rate was as high as 9% and yet household savings, as a ratio of GDP, were practically unchanged.
It’s perhaps too early to look for a demographic dividend, which works by drawing a large number of people out of subsistence agriculture and into factory jobs.
This is yet to happen in India. When it does, savings are bound to increase.
Another impetus may come from higher demand for pension cover, which nine out of 10 Indian workers don’t have at present; this is going to change as the retirement-savings industry modernizes and expands and as more workers join the formal economy, where they have to make mandatory provident-fund contributions.
McKinsey’s prediction of a decline in India’s household- savings rate is perhaps too simplistic.