Opinion
The tumble in India’s savings rate needs to be reversed
Summary
- We need the old formula of fiscal discipline, an inflation vigil, sensible lending and overall macro stability
A farmer has to set aside a portion of the seeds from his harvest to be used for next year’s sowing. Let’s say he puts away 10% of his total output. That produces the same amount of crop next year. If he desires a higher output, then he needs to set aside a higher share of current output. This is the basic insight of the savings rate. What is saved for next year is what’s not consumed. From the aggregate production of this year, let’s call it the gross domestic product (GDP), the portion set aside (i.e. saved) is used as investment (sowing seeds) for future growth. Today’s savings translates into tomorrow’s GDP through a capital output ratio. This is Economics 101. The seeds for next year (i.e. investment) needed can also be borrowed or imported. In which case, the output next year has to factor repayments, interest obligations and exchange rates. Output is produced with a combination of seeds (capital) and the farmer’s own effort (labour). This is the basic growth model, attributed to Roy Harrod and Evsey Domar from the 1940s, and later embellished by Nobel laureate Robert Solow. The intuition that a high savings rate sustains high growth has been tested and confirmed across the world and has withstood all macroeconomic crises and business cycles. Even zero growth needs basic savings and investment to sustain a constant output.
Two questions arise. First, just how much should one save? Too much savings may lead to diminishing returns. There is thus a golden ratio. Besides, if the bulk of savings can come from foreigners, then the domestic population can enjoy a higher consumption level or standard of living. But you can’t borrow indefinitely from the world. Optimal domestic savings is a must.
Second is the question whether savings cause income growth or vice-versa. Higher income makes higher (absolute) savings possible. And higher savings lead to higher growth and income. This two-way relationship has a chicken-and-egg element. Yet, macro policies mandate that higher savings are a prerequisite for high growth.
Much of the East Asian long-term miracle growth was predicated on a high savings rate. In some countries, it has been coercive, with high compulsory savings for pensions. Savings rates have peaked at 50% in China. The flip side of such high and ultimately wasteful savings is that consumer spending as a proportion of GDP is rather low. In China, it was stuck at 35% for a long time, while in India it has been above 65%.
India’s savings rate climbed steadily from below 10% during the 1960s to a peak of 37% in 2010-11. During 2004 to 2012, it was close to the optimal ratio. A combination of high savings, high growth, high tax collections, lower deficits and low interest rates was the virtuous cycle enjoyed by India during the first decade of this century. Then irrational exuberance took over. This led to over exposure to large risky loans in infrastructure and policy paralysis. By 2013, we were in taper-tantrum territory. Unsustainable fiscal spending had led to runway inflation and a falling exchange rate. Later years saw more shocks by way of demonetization, the NBFC crisis, a botched GST rollout and the pandemic. The gross savings rate fell from 36.9% of GDP in 2010-11 to 30.2% in 2021-22.
We need to distinguish between financial and non-financial savings. Roughly 60% of savings are non-financial and go into gold or real estate. This ratio rose to 65% in 2021-22. But financial savings are showing a worrying trend. The Reserve Bank of India reported this week that net financial savings of households have fallen to a near 50-year low of 5.1% in 2022-23. This ratio was 11.5% in 2020-21 and 7.2% in 2021-22. Financial savings are held as bank deposits, stocks, bonds and insurance policies. Households are taking on more debt, and additions to their net financial assets in absolute terms have dropped steeply from ₹22.8 trillion in 2020-21 to ₹13.8 trillion in 2022-23. In 2022-23, growth in household financial liabilities was a whopping 76%. These again rose from ₹36 trillion in July 2022 to ₹47 trillion in July 2023. A big contribution was from non-bank financial companies (NBFCs). Their net credit to households is up 1,000% in one year, from ₹21 billion in 2021-22 to ₹2.4 trillion in 2022-23. Is this loan pushing? Most of the increase is accounted for by loans for housing and vehicle purchases and personal loans. Together these account for 88% of NBFC credit to homes. Are we headed for a housing debt bubble?
The fact is that India’s gross savings rate is still six-percentage-points below the golden ratio needed for sustained 8% growth. The government’s contribution is negative and corporate sector support is also marginal. Foreign savers are fair weather friends who contribute less than 2%. Hence, most of the burden is on the household sector, which has long been of support. But much of what households save is gobbled up by insatiable government borrowing. With high inflation and interest rates, sputtering income growth and lengthening home-loan repayment tenures, we may be headed in the opposite direction of the virtuous cycle seen during 2003-2011. An unsustainable rise in household indebtedness, especially for home loans, is not a sign of confidence. It could be a harbinger of rising bad loans. Rising interest rates are inevitable with a wide fiscal deficit and high inflation. The only way to reverse this decline in our savings rate is the old fashioned way of fiscal discipline, a strict vigil kept on inflation, a tight rein on loan pushing, and overall macro stability.
