THE GROWTH PARADOX : - BY INVESTMENT OR BY CONSUMPTION ?

 

The acceleration of growth of the economy is mostly hampered by the weakening of the savings & investments. Savings & investment rates had steadily gone up from around 10% of the gross domestic product (GDP) in the early 1950s to touch peak levels of close to 40% of the GDP at the time of the global financial crisis in 2007–08. However, it has plummeted and stagnated since then.

The savings rate has slumped from the peak level of 37.8% of the GDP in 2007–08 to 30.2% in 2021–22, a decline of 7.6 percentage points. The fall in investment rates has been even sharper with the numbers going down from 39.8% of the GDP in 2010–11 to 31.4% in 2021–22, a decline of 8.4 percentage points over the period.

The average savings rate shot up from 24% of the GDP in the first decade of reforms to 34% in the second decade but then declined to 29% in the last decade, mainly on account of the slowdown in growth and per capita incomes.

Similarly, while investment rates have moved up from 26% to 36% of the GDP in the first two decades of reforms, it has now shrunk to 33% in the last decade. The twin balance sheet problem, which affected both banks and corporates, also contributed to this decline.

        THE DECLINE IN SAVINGS & INVESTMENTS 

The share of household savings steadily rose in the first decade of reforms and accounted for around four-fifths of the total savings during this period. But household  has been the net lenders to the corporate sector and the government, who are net borrowers.  The corporate sector accounted for three-fourths of the rest and the public sector share was the remaining one-fourth. 

The second decade of reforms saw the share of household’s savings in national saving steadily decline while that of the corporate sector and the government picked up. Thus, the average share of household savings in the total savings declined to two-thirds during this period, while that of the corporate sector rose to a quarter. Public sector savings improved marginally to 6.5%.

In the third decade of reforms, there was a sharp deceleration in the growth of savings of both the households and the public sector, while that of the corporate sector accelerated. Thus, the share of household savings dipped to 63.7% during the period while public sector savings plunged to 1.6% of GDP, a fraction of their earlier share. In contrast, the share of private corporate savings shot up to around a third of the total savings.

Thus, after three decades of reforms, the overall savings rate has increased by 8.5 percentage points to 30.2% of GDP. While public sector savings declined by 2.2 percentage points to 1.1% of GDP during this period, household savings crept up by only 2.9 percentage points to 19.7% of the GDP. The bulk of the gains was in the corporate sector whose share went up fourfold to 10.1% of the GDP. The banking sector’s ability to boost credit growth is limited by non-performing assets (NPAs) and the governance crisis in the financial sector. 

The decline in the overall savings rate is, however, only one part. Of equal concern is the composition of savings. In 2007-08, 51.9 per cent of household savings were in bank deposits, insurance policies, provident/pension funds, shares, mutual fund units and other financial instruments.  

During the years, between 2009-10 and 2012-13,when their annual financial savings fell, households increased their savings in physical form comprised of land and buildings by almost 75 per cent. According to  CSO, Between 2007-08 & 2012-13, investment in valuables – gold and other precious metals, including jewellery increased. One reason for this massive de-financialization of savings has clearly to do with inflation, which reduces the portion of people’s income remaining after consumption to start with. 

When this is combined with negative real returns on bank deposits and other financial assets, even those in a position to save would choose to park their surpluses in real estate, gold and such seemingly better inflation hedges. Savings can also dip when growth slows down, affecting job creation and incomes. 

The decline in household savings has pushed up private final consumption expenditure consistently from 56.21% of GDP in 2011-12 to 59.39% in 2018-19. This suggests that economic growth during 2011-2019 was powered by consumption and not by investment. In contrast, during 2003-2011, growth was powered by investments. Thus, the popular view that economic slowdown was caused due to a slowdown in consumption demand needs to be re-examined.

History shows that no country has succeeded in accelerating its growth rate without raising the domestic saving rate to close to 40% of GDP. Foreign capital can fill in some vital gaps but is not a substitute for domestic resources. Even in China, FDI inflows as a proportion of GDP never exceeded 5-6%, most of which was in fact round-tripped capital through Hong Kong for securing better property rights at home.

According to Dhananjay Sinha, head of equity research at Emkay Global Financial Services, The recent decline in financial savings is attributed to deceleration in salary growth and a steady rise in households’ financial liabilities. Salaries and wages are the biggest source of financial savings for households and there has been a sharp deceleration in employee compensation in recent years due to poor corporate earnings. Salaries are now growing at 6-7 per cent per annum, slower than the corresponding rise in personal loans, exerting pressure on financial savings 

Households are the biggest source of savings in the economy, accounting for nearly 60 per cent of all savings, on average, in the last five years. Lower household savings have depressed the overall savings rate. This has negative implications for the investment cycle, as nearly 90 per cent of the country’s investments are funded by domestic savings. A decline in household savings will translate into lower capital expenditure for the private sector. 

The trends in the investments were also restrained. The total investments have moved up from 18.2% of GDP in the first decade of reforms to 35.9% in the second decade and then slowed down marginally to 32.8% in the third decade. Overall, the three decades of reforms have seen investments move up by 5.7 percentage points to 31.4% of the GDP. 

While public sector investments have gone down by 3.7 percentage points to 7% of the GDP, the private investments (including households & corporates) shot up by 6.5 percentage points to 22.6% of the GDP. The decline in investments has also been exacerbated by the dip in the net capital inflows abroad to just 1.2% of the GDP.

A major cause for concern is the slumping appetite of the corporate sector for new investments. Between 2011–12 and 2021–22, investments by public corporations have steadily declined from 5% to 2.8% of the GDP while that of private corporations went down from 13.3% to 10.8% of the GDP. 

One reason for this steady decline in investment rate on corporations is their diminishing interest in funding new investments through borrowings. While internal savings funded between 70% and 80% of the investments in public corporations in the early years of the decade, the share has now gone up to between 90% and 100%. This scenario is also visible in the case of private sector corporations where the share of investments funded by savings has gone up even faster.

Gross FDI inflow into India peaked in 2008-09 at 2.7% of GDP, decelerating thereafter. As it increasingly consists of private equity (PE) with a three- to five-year tenure, mostly acquiring capital assets (contrary to the conventional FDI definition as fixed capital formation for the long term) net FDI rate is lower than the gross inflows, standing at 1.5% of GDP in 2017-18.

India’s exports-GDP ratio declined from 24.54% to 19.74% during 2011-2019. The decline started from 2014-15, coinciding with a similar trend in the world export-GDP ratio. The excessive reliance on internal savings to finance new investments and the reluctance to borrow to finance new projects clearly show that investor confidence in the economy has been badly singed. Only a sustained revival in demand will help improve business confidence and push up invest­ments. 

This will require that the government discard its fiscal priorities and massively expand employment generation and welfare programmes which will help kick-start demand, restore business confidence and boost savings and investments. It is now time to rework the policy framework and boost growth.