India’s growth story has witnessed a bumpy ride since the Lehman Crisis. Annual GDP growth dropped to 6.7% in FY09 from 9.3% in the preceding year. However, growth quickly recovered to over 8% in the next two fiscals supported by strong fiscal and monetary stimulus, leading to a strong consumption growth. However, the consumption-led revival was short-lived and India’s GDP growth fell to a decadal low of 4.5% in FY13, recovering mildly to 4.7% in FY14.
While these numbers are definitely worrisome, the drivers of growth are more disappointing. While consumption and investment contributed nearly equally to GDP growth in the pre-Lehman years, it was the former that dominated in the post-Lehman period. Average share of consumption in GDP growth rose from 57% in pre-Lehman period to 83% in the post-Lehman period, while that of fixed investment fell from 51% to 27%. In fact, contribution of fixed investment to growth was minus 0.7% in the most recent fiscal—FY14.
That’s not a good sign! Consumption-led growth is not sustainable in the long run if it is not complemented with additional capacity creation in the economy. Lower investment rate also leads to lower employment and income growth, adversely impacting consumption. To fund this increased investment, savings are needed, which are not in a good shape either. In this column, we look at the trend and composition of savings and investment.
The total savings rate has witnessed a significant decline in the post-Lehman period. It fell from a peak of 36.8% of GDP in FY08 to 30.1% in FY13. Average annual growth in domestic savings too fell drastically from 22.9% in pre-Lehman period to 11.0% in the post-Lehman period.
While the overall savings rate has come down sharply, a more disturbing trend lies in its composition. Total domestic savings comprise household, private corporate and government savings. The household sector is the biggest contributor to overall savings, accounting for almost 70% of total savings. In the post-Lehman period, household savings witnessed a significant shift towards savings in physical assets. The share of financial savings in total household savings went down from 51.9% in FY08 to 32.4% in FY13. The household sector’s financial savings rate fell from 11.6% of GDP in FY08 to 7.1% in FY13, while the physical savings rate rose from 10.8% to 14.8% during the same period. This movement of household savings away from financial assets reduced the available capital for investment in the country.
One possible explanation for the change in the pattern of the households savings could be the return on different asset classes. Average annual real returns on the stock market plummeted from 33.9% in the pre-Lehman period to minus 2.9% in the post-Lehman period. Similarly, returns on savings deposits too fell in the post-Lehman period. Real returns on physical assets like gold were not only higher than financial assets in the post-Lehman period, but were also higher than the returns on the same in the pre-Lehman period. Average annual real returns on gold went up from 8.6% in the pre-Lehman period to 12.5% in the last five fiscals. As household sought higher returns on their savings, investments in physical assets formed a larger chunk of their portfolio.
On the corporate side, savings fell from 9.4% of GDP in FY08 to 7.1% in FY13. Along with the fall in savings rate, investment rate in the economy has also fallen. Investment rate fell from 38.1% in FY08 to 34.8% in FY13, much more sharply than the savings rate. In the investment side of the story, behaviour of the private corporate sector plays a crucial role, like households in the savings story. While share of public sector in total fixed capital formation (governed by fiscal policy) has remained more or less steady around 25%, that of private corporate sector has come down to 27.9% in FY13 from 43.3% in FY08. Private corporate investment has fallen from 14.3% of GDP in FY08 to 8.5% in FY13. The sharp fall in corporate investment has been the prime reason for the recent investment slowdown in the economy.
However, what is interesting is the fact that while both corporate investments and savings have fallen, the fall in investments is much sharper. While the corporate savings rate fell by 2.4% between FY08 and FY13, investments fell by 5.8% during the same period. This points to the fact that in the post-Lehman period, corporates are hesitant to invest, in spite of having money to do so. This fact is further bolstered when we look at the ratio of savings available with the corporates to undertake investment. This ratio has risen to 83.3% in FY13 from 65.9% in FY08. Weak domestic and global economic environment coupled with domestic policy log jam kept the corporates at bay from undertaking fresh investments. Weak business expectations are reflected clearly in RBI’s quarterly business expectations index. The index for expectations on next quarter averaged 115.9 in the post-Lehman period, down from 122.1 in the preceding five fiscals. What matters more for the private sector to invest is the expected rate of return on their investment which, in a weak economic environment with regulatory hurdles, was not very favourable.
To put the Indian economy back on a path of sustained growth, policy-makers will need to revive investment as soon as possible. Studies have shown that overall investment climate and economic conditions and not just the interest rates, are more crucial in determining investments. Hence, the onus of reviving the economy lies more with Modi in Delhi than with Rajan in Mumbai.
To fund this investment, savings will also have to increase commensurately. The ratio of gross domestic savings to gross fixed investment has fallen to around 98% in the last two fiscals from over 110% in the pre-crisis period. On the savings front, RBI seems to be faring pretty well with success in taming inflation. Real interest rates have turned positive only in recent months, thanks to falling inflation—a positive for financial savings. Yet, much more needs to be done to deepen and broaden India’s financial markets so that they can be made more lucrative for the households with greater returns.
The most worrying trend right now is that the gap between physical and financial savings is the widest in the past decade. Apart from providing a hedge against inflation, this trend clearly reflects the unattractiveness of other financial saving instruments. Tapping the rural market for mobilising financial savings will be very critical as for the rural unbanked sector, gold remains an important saving instrument. The idea of turning India Post into a bank could prove to be beneficial for the government’s larger agenda of financial inclusion. Similarly, the government’s commitment towards providing basic savings account with zero balance and micro insurance products to the account holders is a step in the right direction.
By Anuj Agarwal & Prachi Priya
Authors are corporate economists based out of Mumbai
