Sustaining growth needs higher savings

It is a truism that reduction in poverty needs higher economic growth, which can create jobs and incomes. India’s per-capita income at 3000 dollars, or about 2.4 lakh rupees per annum is the lowest among all G20 countries. Compared to the two largest economies, it is respectively one fifth, and one twentieth of per-capita incomes of China and United States. To get to a reasonable development status, India’s national income must rise at seven to eight percent in real terms (i.e., after adjusting for inflation) every year for at least a couple of decades. This growth in national income must also be relatively evenly spread and not causing further inequality.

One of the most important requirements for high income growth is the national rate of savings. This is that part of national income, which is set aside, for investing into the future. That investment goes toward building new factories, infrastructure or more importantly into strengthening education, research, innovation and entrepreneurship.  India’s highest national savings rate of about 37 percent of GDP was attained in 2010-11. 

Growth in national income must also be relatively evenly spread and not causing further inequality

Currently it is about 30 percent, which is a fall of 7 percent of GDP. This needs to be reversed. Of the 30 percent aggregate savings, roughly 20 percent comes from households. That includes small and tiny businesses, often unincorporated and in the informal sector.  Keep in mind that the aggregate savings of all households come from the relatively better off, i.e., rich people. Poor people cannot afford to have high savings. Their entire income goes to meet their consumption needs. When consumer items like food, milk, transportation, children’s education and medicines become expensive, that eats into their income. If their (nominal) income is rising slower than the rate of inflation, then that further cuts into their savings.

India’s aggregate household savings has traditionally been divided half and half into financial and non-financial savings. The latter is the money put into buying real estate or gold. The former is that part of the savings which go toward bank deposits, mutual funds, bonds, pensions and insurance.  As the financial sector deepens, and the trust of the people in finance increases, then they choose to park more of their savings away from gold and real estate. Gold is seen as protection against inflation. India has the highest demand for gold in the world. Gold imports result in an outgo of precious foreign exchange.

The net financial savings of households have fallen to 5.1 percent of the GDP in 2022-23, which is the lowest in almost fifty years

During 2021-22 gold imports cost the country 46 billion dollars, which thankfully went down to 35 billion dollars during 2022-23.  But household savings continue to tilt toward non-financial savings which must be reversed. If people are buying less gold but more of real estate, that is seen as confidence and building assets. However, it is still less productive than financial savings which are intermediated by the banking system and capital markets, toward real investment like new factories and infrastructure. When financial savings go down, then the supply of loanable funds go down causing interest rates to go up. The lack of domestic financial savings can be made up by the inflow of foreign capital, either as equity or foreign loans. But the latter creates dollar indebtedness for the country, which is not desirable.

Net financial savings of households are the net of their financial liabilities, which are basically loans. The net financial savings of households have fallen to 5.1 percent of the GDP in 2022-23, which is the lowest in almost fifty years. This is alarming. It fell from 11.5 percent in 2020-21 to 7.2 percent in 2021-22 and to the present 5.1 percent. During the same period financial liabilities (which are usually roughly three fourth of financial savings) have risen steeply.  Households borrow from banks as well as non-banks.

Is a loan bubble building up in the NBFC sector, which can burst with the economic downturn?

 If financial liabilities rise alongside financial savings, the net financial savings as a percentage of the GDP would remain roughly constant. But the fact that there has been a steep fall in the net financial savings, means financial liabilities have risen more sharply. Indeed, during July 2022 to July 2023, the financial liabilities of households rose from 36 lakh crores to 47 lakh crores. The previous year too there had been an increase of a whopping 76 percent. And the borrowing spree in not from banks, who have been relatively prudent. Bank credit to personal loans, credit cards, housing and vehicles has risen. But the biggest increase has been from non-bank finance companies.

There are stories wherein some loan duration has been extended to 40 years. How will these be fully repaid?

The net credit of NBFC’s to households rose from 21,000 crores to 2.4 lakh crores just in one year, i.e. from 2021-22 to 2022-23. Financial liabilities of households to NBFC’s shot up to 15.2 percent from a mere 2.4 percent the previous year. Now you can imagine the impact of those pesky calls selling you personal loans on your mobile! Does this amount to loan pushing?  Are the NBFC’s taking on more risk than they should? Is a loan bubble building up in the NBFC sector, which can burst with the economic downturn?

Since inflation is running high, and interest rates are high, the housing loans are under pressure. But since the Equated Monthly Installment (EMI) cannot be increased, the duration of the loan has been elongated by the lender. There are stories wherein some loan duration has been extended to 40 years. How will these be fully repaid?

The fall in net financial savings is alarming, and there is no solace in saying that it simply reflects more willingness of households to take on personal and housing loans. The aggregate savings of the economy is also 7 percentage points below its peak. A high savings rate is essential to sustain high growth. The falling savings rate is further compromised due to the voracious appetite of government borrowing, both at the Centre and at the State levels. Almost the entire household financial savings gets pre-empted by the sovereign and sub-sovereign borrowing requirement. India now hopes to garner fresh dollar loans of around 20 billion dollars into the sovereign debt market, thanks to India’s inclusion in the J P Morgan bond index.

But the need to reverse the fall in savings rate and net financial savings is dire. That also requires a lower and stable inflation rate and a tighter control of fiscal borrowing.

(Dr. Ajit Ranade is a noted economist)