Previous cycles suggest growth and savings are actually led by investment. Reviving investment in the economy will boost savings
Much is made of the fact that household financial savings have fallen and are barely adequate to meet the public sector borrowing requirement, let alone lend to the private sector. This is argued to be a key constraint in raising Indian growth rates, since it keeps interest rates high. But there are a number of inadequacies in this analysis.
Investment- or savings-led?
Historically, the ratio of Indian savings to the GDP has fallen in low growth periods, and risen when growth is high, although financial sector development has also affected it. After peaking in the 1970s at about 20 with bank nationalisation, it fell with stagflation and a fall in public sector savings reaching 17 in the mid-1980s. It had recovered to above 20 before the liberalising reforms came. As it stagnated below the 1978-79 peak of 23.2, a debate in the early 1990s echoed current concerns that raising growth would be difficult because of the fall in savings.
But growth jumped up in the late-1990s, and savings increased to above 25. The sharpest rise came with the 2000 growth boom. In 2010-11, the savings ratio peaked at 33.7. As growth fell after 2011, the savings ratio fell with it. In 2017-18, it was 30.5. That turning points in the gross domestic capital formation (GDCF) normally led those in savings suggests that growth was investment-, not savings-led. Savings rose as investment raised job and incomes, while consumption growth lagged. Consumption habits are slow to change.
Aggregate savings did fall after 2011-12 with lower growth, but part of the decrease in estimated household savings ratios may only be due to changes in measurement.
In the new GDP series with 2011-12 as base, some household physical savings were transferred to corporates, as the corporate base was expanded to include the unorganised sector. Even so, both remained higher in the spliced new series compared to the old, with the rise in corporate savings more than that in household savings. But while household savings fell over time after 2011-12, corporate savings rose. Part of the decrease in household physical savings may be an artefact, since they are measured as a residual. They are the same as household physical investment and are derived by subtracting corporate and government investment from the total estimated by the commodity flow method. In this benchmark, estimates and proportions are used for measuring the production of goods. As use of a larger corporate database improves the estimation of one part relative to the whole, the residual could shrink.
Even so, now household net financial savings are not the only source of financing for corporates. Household net financial savings at present are adequate only to cover government net dissaving; a rise in corporate investment above own savings can be financed by foreign savings and domestic credit, even as it induces a rise in incomes and domestic savings.
It is not necessary to have full financing before you begin a project. In fact, this almost never happens. Borrowings are repaid and equity serviced as a firm begins to earn. Similarly, for a country, a switch to a higher growth path normally sees the marginal propensity to invest rise above that to save. But total savings and savings ratios rise even as propensities to save fall below propensities to invest. Consumption is thought to follow and not drive growth, but then the same must be true of savings.
Although a growth cycle led by private investment in infrastructure — like in the mid-2000s — is unlikely , the entry of FDI, planned government spending on infrastructure, and a credit-financed rise in durables consumption could induce a rise in private investment.
In an open economy, foreign savings are also available to finance a short-term gap, but proper intermediation and availability of domestic finance is also necessary for the switch and for long-run sustainability of growth.
But Indian credit growth has slowed. According to BIS data, increase in Indian ratios of total debt, debt to government and to non-financial corporations over 2011-15, a period of high global liquidity, was below the global increase. The government was reducing its fiscal deficit and firms were borrowing little. For Indian non-financial corporations, the ratio increased only by 0.3 compared to 29.4 for other emerging markets, for households 1.2 compared to 6.9, and for government 1.9 compared to 6.1. This does not account for informal finance, but shows the stagnation in formal finance.
A slowdown in bank credit growth followed escalating provisioning requirements after the Asset Quality Review. An immediate recap was required. But the latter had to await the Insolvency and Bankruptcy Code (IBC) and governance improvements. NBFCs began to substitute for banks. Demonetisation brought in huge amounts of liquidity into the formal banking system. Some NBFCs found it profitable to borrow short at cheap rates and lend long.
Regulations should have been tightened at this time. Instead, the rise in credit was welcomed. And when markets froze after the IL&FS collapse, no immediate liquidity was provided. Regulation was pro-cyclical. Systemic spillovers meant markets were shaken by rumours of firms in trouble. Lending from NBFCs contracted. Funds to the commercial sector fell from above ₹7 lakh crore in April to mid-Sept (H1) 2018-19 to below ₹1 lakh crore in H1 2019-20. The plunge in consumption, investment and GDP growth was not surprising.
Signs of recovery
However, the IBC has begun delivering. Banks have recovered money as well as received capital from the government. Writing back provisioning will add to profits. Net NPAs have fallen to low single digits. Banks have begun lending again. A number of fiscal measures have been announced. Slow-moving government schemes, some through banks, have begun providing funds to NBFCs. Liquidity is plentiful and loan rates are falling.
Despite stress, markets have been able to absorb a number of shocks, pointing to the maturity, diversity and resilience that comes with size. Foreign equity sees the opportunities. Stock markets are booming as inflows surge. The stage is ripe for reinforcing changes to raise marginal spending and tip the economy towards higher growth. Indeed, this is essential to prevent the slowdown from deteriorating asset quality further.
While savings ratios will improve with the cycle, incentives can help raise savings over the long run. In high-saving countries such as Japan and Canada, tax breaks and behavioural tweaks encourage pension and targeted savings, while high-consuming US had tax breaks for interest on consumption loans.
Indian tax systems should systematically favour savings over consumption, although tax breaks can continue for assets such as housing.
The writer is Professor, IGIDR, and Member, EAC-PM