Improving India’s savings rate

The vote on account to be presented in the Lok Sabha on 17 February comes against a number of unhappy macroeconomic trends in India. In recent weeks, the country has posted not so happy economic data. Advance estimates for gross domestic product (GDP) growth for 2013-14 are one of the lowest in a decade. Along with this number, the savings rate has fallen to a nine-year low. From a peak of 38.1% of GDP in 2008 (when India seemed to have entered a virtuous cycle of savings and growth), in 2012-13, the savings rate has fallen to 30.1% of GDP from 31.3% in 2011-12, the fourth consecutive year in which it fell.

No one expects the government to be a big saver; it will be great news if it is able to hold on to its original expenditure and fiscal deficit targets.

The picture is not a happy one to look at. In India, the biggest source of savings is the household sector, followed by the private corporate sector and the public sector. Household savings fell by almost one percentage point from 22.8% of GDP in 2011-12 to 21.9% in 2012-13. The fall in private sector savings was marginal—0.2 percentage points from 7.3% to 7.1%—while the savings rate of the public sector remained unchanged at 1.2% of GDP. In the last nine years, however, the rate of savings in the public sector has more than halved from 2.3% of GDP in 2004-05 to 1.2% in 2012-13.

This is a worrying trend. Even if one discounts the policy problems that prevent a higher rate of investment, the fall in savings has undercut the very basis of growth in India. To further complicate matters, the switch in the composition of household savings—from financial to physical assets—cannot be altered overnight. The gap between financial and physical savings is now the widest in the last 13 years.

So what did Indian households do with these so-called dissavings? One part of the answer can be seen from the current account deficit (CAD) data for 2012-13. In the first half of that year, CAD was hovering around 5% of GDP. One reason for this was the huge and almost insatiable demand for gold.

Even if one agrees that a part of the demand for gold is speculative, inflation-hedging remains an important reason why Indians want to buy gold. While household savings have averaged around 22% of GDP in the last few years, there has been a near four percentage point shift in savings away from financial to physical assets such as real estate and gold.

This is not a sudden shift in preferences for savings instruments. The story is one of rising inflation and the changing demand of households for savings. There are various components to this change. At one level, insurance products lost their sheen after a host of problems in the sector (including mis-selling), at another, equities lost their charm. In rural areas, which remain largely unbanked till date, gold remains an important savings device.

At the moment, CAD, which is the gap between domestic savings and investment—may point to a comforting direction. In 2013-14, CAD is expected to be less than 2% of GDP. So does this mean that savings will begin swelling again and households will start investing in financial assets again? The answer is not clear. For the moment, this so-called problem has been sorted out by a massive increase in duties on gold and physical restrictions in its import. But the problem cannot be wished away.

This tangle cannot be sorted until the government gets inflation under control. Which brings us to the original point: the level of government savings has to go up and for that credible fiscal consolidation is necessary. The chain that has led to a lower rate of savings in the Indian economy—from huge increases in government expenditures to rising inflation and a switch in savings from financial to physical assets—has made mobilization of savings difficult.

It is for this reason that the fine print of the vote on account should be watched carefully. The government’s ability to hold fiscal deficit at 4.8% of GDP is suspect not because this number cannot be printed in the budgetary document but because it may come about after creative accounting. Its effect on the Indian economy will not be so creative.

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