The euphoria over savings rate

Financial Express, 28 March 2006

In the euphoria about the headline data about the sharp rise in the

gross savings rate in India, one fine detail has been ignored : the

maximum increase in savings has come from the most unreliable source -

public sector savings. Before we raise our hopes about savings,

investment and growth in India, and before we start thinking that the

higher GDP growth will give the government higher taxes and more money

to spend on employment guarantee programmes and pay commission

recommendations, we need to pause to refect upon the source of higher

savings which is supposed to make all this possible.

First the arithmetic. In period from 2001-02, there has been an

increase in the investment rate by 7 percent of GDP. The investment

rate rose from 23 percent in 2001-02 to 30.1 percent in 2004-05. This

investment was financed by a rise in both the gross savings rate and

net capital flows from abroad. The domestic savings rate rose over

this period from 23.6 percent in 2001-02 to 29.1 percent in

2004-05. The net capital inflow swung from a net outflow of capital

from India of 0.7 percent of GDP in 2001-02, to 0.8 percent of net

inflow of capital into India in 2004-05.

Public savings consist of dissaving by the government and savings of

public sector enterprises. Public savings have shown a remarkable

swing. In 2001-02 the public sector as a whole was making losses of Rs

46,377 crore. In 2004-05 the government and public sector enterprises

together saved Rs 69,390 crore. This was a shift from -2.0 percent to

a postitive of 2.2 percent of GDP.

One part of the increase in the public saving rate has been achieved

by fiscal consolidation at both the state and central levels. The

combined revenue deficit of the central and state governments has

fallen sharply from 7.0 percent of GDP to 3.4 percent in 2005-06

(Budget Estimate). The combined fiscal deficit of the centre and

states has fallen from 9.9 percent of GDP to 7.7 percent over this

period. A higher growth in revenues at a time when the economy is on

the upswing of a business cycle has made the improvement in public

finances possible. While one can hope that the FRBM will tie the

hands of the centre as well as the states that have adopted it, the

cyclical aspect of tax revenues must not be forgotten. Lower GDP

growth would mean lower savings as taxes have higher buoyancy than


Though the deficit of the government has fallen as a share of GDP, it

has increased in rupee terms. This increase has, however, been offset

by the profit growth in public sector enterprises which has resulted

in a swing from a public sector deficit to a surplus. Most public

sector enterprises make losses. In general, only PSUs that are in a

monopolistic position such as oil companies and banks are able to make

profits. Retained profits by such companies is the primary source of

the observed increase in savings.

Corporate savings, which reflect higher retained profits of the

private corporate sector, have also risen from 3.6 percent of GDP in

2001-02 to 4.8 percent of GDP in 2004-05. One element of the

explanation for the increase in profits in both PSUs and the corporate

sector is that the period under discussion is one in which industry is

on the upswing of a business cycle.

Profits are amongst the first to be hit when a business cycle turns

and should not be thought of as giving a "trend" increase in the

savings rate. An increase in savings is more likely to be permanent

when it comes from households. But household savings, where a

'demographic dividend' in terms of a larger and younger earning

population with higher incomes is expeced to raise the household

savings rate, is yet to see a rise. Household savings as percentage of

GDP remained flat at 22 percent. While it is correct to think that

India's household savings rate will rise because of the demographic

shift taking place in the population today that is reducing the

dependency ratio, the shift could take about a decade.

In conclusion, the details about the source of higher savings suggest

that there is no room for complacency. The government should continue

to control its expenditure, rather than make plans to expand it.


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