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
expenditures.
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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