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Photo: Bloomberg
Photo: Bloomberg

Opinion | A case of wilful spenders turning into forced savers

A consumption led recovery can’t be counted upon but a rise in savings could help fund fiscal spending

As India unlocks, consumers are likely to unleash a wave of pent-up spending that will send retailers scrambling to restock their shelves and bolster manufacturing activity. But how long will this burst of demand last? And then what?

Consumption has been the undisputed saviour of India’s economy during previous periods of stress. Over the last 10-odd years, when investment growth was sluggish, spending by individuals propped up growth.

Typically, it’s been non-durable goods—those which tend to be more essential in nature, like food—that have led the recovery. This is understandable. When labour markets are weak, households focus on the essentials more than on discretionary items like vacations and luxury goods. About 55% of the consumption pie comprises essential goods and services, while the remaining 45% comprises discretionary goods and services.

If past trends are followed, demand for essential goods and services, which make up a third of gross domestic product (GDP), is likely to lift growth over the next month or two. The next obvious question is—what next? Once the wave of pent-up demand is gone, what will drive growth?

To sustain the recovery, economies need to move up the value chain. This means people need to move from just spending on essentials to also spending on durables, which finally makes way for private investment. Will India follow this path through to the end this time around?

A study of India’s recent growth history highlights the importance of ‘enabling factors’ in moving up the value chain. During the Global Financial Crisis (GFC), growth recovered quickly and labour markets strengthened on the back of strong fiscal and monetary policy stimulus (which may have even been a bit excessive, in hindsight).

During 2014-2018, free-flowing personal loans from both banks and shadow banks helped raise demand for consumer durables, despite weak wage growth. A side effect of this was a 10-percentage-point rise in household debt, taking it to about 30% of GDP, as households spent by dipping into savings and taking loans, thus using their future earnings rather than current incomes.

Unfortunately, neither of these enabling factors are available in abundance right now. The reason for this is the stretched balance sheets of key economic players. The government’s fiscal position was stretched even before the crisis, and a shortfall in revenues this year could make things worse. While the government can perhaps provide a slightly bigger stimulus than it already has, it’s unlikely to be a large “permanent" stimulus like during the GFC days.

The balance sheets of banks are also burdened with already high and now rising non-performing loans. And India’s shadow banks have their own liquidity issues. As such, both banks and non-banks have become much more risk averse and may not want to give out personal loans as freely as they did in 2014-2018.

To be fair, even demand for loans might be rather weak. Household debt has risen rapidly over the last few years, and if incomes continue to decline, consumers may not be too keen to take on new debt, fearful that it would be tough to repay it.

All told, households saturated with debt, banks that are risk averse, shadow banks unwilling to lend, and social distancing that could continue well after the lockdown ends may all be too big a hurdle to boost discretionary consumption.

For all the same reasons, India’s saving rate, the other side of the consumption coin, could rise. Recently released data shows that even before the covid outbreak, net financial savings ticked up in 2019-20, led largely by softer bank borrowing. And in 2020-21, already, deposits at banks are growing rapidly, climbing 11% year-on-year in May (at a time when nominal GDP growth is likely to contract sharply). And this high deposit growth comes despite a sharp fall in interest rates.

This rise in India’s saving rate throughout the covid episode could have several macro-economic implications. One, if savings rise, it means consumption may not be as dependable a driver of growth as in the past. Two, higher savings mean that the current account deficit may remain contained for longer. Finally, higher financial savings at a time when private demand is weak means that higher public sector borrowing may get more easily funded, at least temporarily. No surprise then that despite plans by the government to borrow heavily, bond yields haven’t spiked.

If consumption cannot be counted upon to raise India’s GDP growth sustainably, and an investment revival is even further away, what can the authorities do to fill the gap?

One, the government can spend a bit more than announced currently. The previous rounds of fiscal stimulus (amounting to 1% of GDP) have not touched upon some sectors like the urban poor. Rising financial savings, surplus banking sector liquidity, and, if need be, the central bank could support the extra borrowing.

Two, the government needs to carefully choose the most pressing supply-side reforms and implement them quickly, for instance cleaning up balance sheets (via an easier bankruptcy process for example), and ensure that any demand uptick is not met with supply-side constraints like lack of finance or labour.

When consumption cannot be counted on, these two factors will become even more important to support a revival.

Pranjul Bhandari is chief India economist at HSBC

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