Try debt, dear Henry, try debt

The best laid plans of men and mice, says the Scots, have a way of going awry. Yashwant Sinha is not from Scotland but he must surely be in wholehearted agreement with this adage.

On February 28 he has presented the Budget for 2001-02 with the hope springing in his heart that if he provided sops like tax reductions on dividends and exemptions on capital gains for those investing in IPOs, people would rush towards the stock market.

That hope has now been dashed and the dream budget has been quickly followed by a nightmare. Instead of going up, the market has seen the biggest post-budget fall in ten years. As if the Tehelka was not enough, news about sleaze in defence deals rocked the market further.

Given the ways of the stock market it is legitimate to ask, won’t these yo-yo movements stabilise after some time? Or are they important enough to hurt the real economy?

Unfortunately, loss of investor confidence may affect investment and production more than it otherwise would have had. This is because many of the calculations in Yashwant Sinha's budget depended on a positive view of the stock market.

By cutting interest rates on the Public Provident Fund and other small saving schemes and not raising tax exemption limits for these significantly, the FM made these assets less attractive to the public. One consequence of this, it was hoped, would be a diversion of household financial savings towards the private sector as the government has often been accused of pre-empting household financial savings. While the government (and LIC) owe households nearly 5.6 per cent of GDP, only 0.31 per cent of GDP is held by the household sector in shares and debentures.

The importance of household saving in the resources available for investment cannot be over emphasised. Total domestic savings constitute about 22.3 per cent of GDP (1999-2000). With foreign capital inflows (FDI,FIIs, foreign debt ) to adding to the resources available, last year gross domestic investment as a proportion of GDP was 23.3 per cent.

If economic growth is to be raised investment will need to be stepped up. To raise resources for additional investment either the public or private sector must save, or additional foreign capital must flow into the country.

Consider each of these. Public sector saving trends are most discouraging. From being a net saver till 1997-98, the public sector (the government sector and public sector enterprises) has become a net borrower of funds. In 1998-1999 it borrowed 0.8 per cent of GDP. This figure rose to 1.2 per cent in 1999-2000.

For the last two years there has been very limited progress on sale of loss making public sector units. Indeed, evidence from other countries suggests that while it is relatively easy to sell off profit making enterprises, it is not so easy to sell loss making public sector units.

The political controversy surrounding BALCO is only a jhalak of the turbulent times that lie ahead. It remains to be seen if the disinvestment target will be met this year and what the net effect on total public sector savings is. Because the loss of profits from the sale of profit making enterprises will offset some of the income earned from sale proceeds.

Table 1: Private and Public Savings

Foreign capital flows have to be accommodated largely by the trade deficit (imports of goods and services minus their exports) . As a matter of accounting, the amount the country as a whole borrows from the world (foreign investment) is matched by the amount it imports more than it exports. This is the additional amount it owes the world in a particular year.

Trade deficits of over 2 percent are usually viewed with suspicion for a developing country like India. Thus India's capacity to absorb foreign investment is constrained by this consideration. Currently the level is one percent.

Private savings consist of savings by the household and the corporate sector. In 1999-2000 household savings constituted over 19 per cent of GDP. Corporate savings constituted 3.7 per cent of GDP. Household savings are thus a very important part of the total savings in the economy. Since both public sector savings and foreign capital inflows are going to be limited, it is essential that there are incentives in place to raise private savings.

The main way this could be done is through the development of a debt market, especially a retail market for government securities. This will offer low risk investment opportunities for the small investor. In addition to a primary market, development of a secondary debt market is necessary to provide liquidity.

The budget has made proposals to develop and deepen the debt market. In the light of the developments in the stock market it is essential that these proposals be implemented seriously. Not only will that be crucial to offer protection to the small investor by giving him risk free assets, it could play an important role in raising the savings rate.

It this is not done then with the stock market crisis and loss of confidence, there is a danger that households may not invest more in the stock market. With a reduction in the attractiveness of public savings, the incentive to save, especially financial savings, will be less and consequently household savings may decline. Investment in an economy must be financed by savings, and that too mainly domestic savings. Out of these household financial savings are a very large and important component. If household savings fall, total domestic savings may fall. Then it will not be possible to finance additional investment and raise growth.

Table 3: Private Savings: Household and Corporate