Active Stocks
Thu Dec 07 2023 13:12:03
  1. Bharti Airtel share price
  2. 1,003 -2.05%
  1. Tata Steel share price
  2. 130.45 -1.02%
  1. Power Grid Corporation Of India share price
  2. 229.2 2.14%
  1. Wipro share price
  2. 419.3 0.11%
  1. Tata Motors share price
  2. 722.2 -0.03%
Business News/ Opinion / Columns/  Opinion | The covid shock could alter people’s financial priorities
Back Back

Opinion | The covid shock could alter people’s financial priorities

We should expect Indians to increase their precautionary savings over time to come in response to income volatility today

Photo: iStockPremium
Photo: iStock

Will the financial choices of Indian households change in the years ahead, well after the covid-19 shock dissipates? And how will they change? The answers to these two questions have immense implications on public policy choices right now.

Economists usually believe that there are two ways households react to income volatility of the sort we are seeing right now. They borrow to protect consumption levels in case they expect the income shock to be temporary. They increase savings to meet wealth targets in case they expect he income shock to be permanent. In more technical language, they either smoothen consumption by borrowing, or they smoothen savings by cutting down on consumption. The choice depends on how they read the future.

The probability of the second alternative will increase in case today’s economic pain deepens. Households will reassess their expectations of future income, and will alter their financial choices. People hold financial assets for three main reasons—for daily transactions, for speculation and for precaution. These categories sometimes overlap. However, precautionary savings are particularly important for answers to the two questions posed at the beginning of this column.

John Maynard Keynes had pointed out that the motivations for these three types of savings are different from each other. Money held for the speculative move is sensitive to the interest rate. Money held for either the transactions or the precautionary motive is not sensitive to the interest rate. Precautionary savings tend to rise under conditions of income uncertainty. People who have lived through a storm understand the importance of setting some money aside for rainy days. Evidence ranging from Europe after World War II to the developed countries after the North Atlantic financial crisis suggests that precautionary savings increase after a deep crisis.

There is thus a strong likelihood that the income uncertainty people are experiencing right now will nudge Indian households to increase precautionary savings at least for the next few years. And this psychological switch may persist even after the Indian economy recovers momentum. The lack of a social security net—and the inadequacy of income support in the current crisis—makes a spike in precautionary savings even more likely in the country.

Why does this matter? Three possible macro effects of higher precautionary savings are worth highlighting. First, discretionary spending could come down as a proportion of income as households save more. Second, higher demand for safe assets such as bank deposits or government bonds could create space for fiscal expansion till private sector investment picks up. Third, higher savings could impact India’s current account balances with the rest of the world.

None of this is a given. For example, it is quite possible that households choose to save in physical assets such as land or shift money into the stock market. However, the most important predictor of how precautionary savings behave in the coming years is whether Indian households will interpret the income shock they experience this year as a temporary blip or a permanent setback. It is, thus, as psychological as it is economic.

Some of the latest trends in financial choices are worth mentioning in this context. In the first two weeks of the new financial year that began in April, Indians reduced the money they hold in demand deposits by 1.3 trillion, while they increased the money they have in time deposits by 2.8 trillion. Cash holdings have also gone up by 41,583 crore. (Time deposits of banks include fixed deposits as well as the time component of savings bank deposits.)

Such a strong preference for time deposits was being seen for some time now. In the earlier financial year that ended in March, time deposits accounted for nearly 90% of the increase in total bank deposits—or almost 20 percentage points higher than the average since the turn of the century. The lowest point was after demonetization, when demand deposits swelled as citizens rushed to exchange old bank notes for new ones.

There is right now no trustworthy data on how most Indians are dealing with the income shock. Some must be dipping into their savings. Others may be borrowing through social networks. The lack of consumption opportunities during the lockdown may have inadvertently increased the savings of the lucky few who have steady incomes. Savings behaviour is complex. It depends on everything from the interest rate to bank-branch access to substitution between alternative channels.

But the most important factor is income—and especially expectations of income over a longer period of time rather than what you earn today. It is these expectations that give a young professional the confidence to borrow for a house purchase that she cannot afford on her current salary, and it is the same expectations that make another young professional play safe by building a financial buffer against income uncertainty. Income volatility amid the current turbulence can lead to a rise in precautionary savings. Policy economists will have to focus more closely on this issue.

Niranjan Rajadhyaksha is member of the academic board of the Meghnad Desai Academy of Economics

Milestone Alert!
Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 05 May 2020, 09:58 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App