The Reserve Bank of India released the financial stability report on June 27, 2013. The page 14 of the points out “Gross Domestic Saving as a proportion to GDP has fallen from 36.8 per cent in 2007-08 to 30.8 per cent in 2011-12.”
In the year 2004-2005, the total domestic savings had stood at 32.4% of the gross domestic product. Hence, there has been a tremendous drop in savings during the time the Congress led United Progressive Alliance (UPA) has governed this country. And this as we shall see is one number that is a broad representation of all that is wrong with the Indian economy in its current state.
The total amount of money that a country saves essentially comes from three sources: households, the private corporate sector, and the public sector. The worrying thing here is that household savings have fallen dramatically during the last seven years.
As the Economic Survey released in February 2013 pointed out “On average, households accounted for nearly three-fourths of gross domestic savings during the period 1980-81 to 2011-12. The share declined somewhat in recent years, and in the period from 2004-05 to 2011-12, it averaged 70.1 per cent of total savings.”
The other worrying factor is the dramatic fall in financial savings, which have pushed down overall domestic savings as well. As the RBI report points out “A large part of this decline has been due to fall in financial savings of households which have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.” Financial savings essentially accounts for savings in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore.
So the question is why have households savings and within them household financial savings, fallen so dramatically over the last few years? A straight forward answer is high inflation. The high inflation that has plagued the country during the course of UPA’s second term has meant that people have had to spend more money to buy the same basket of goods as they were doing the same. And this has meant lower savings. What this also tells us is that newspaper stories that talk about salaries in India going up in double digit terms, need to be taken with a pinch of salt, given that inflation has also more or less gone up at the same rate.
Also high inflation has meant that the real rate of returns after adjusting for inflation on products like public provident fund, bank deposits and post office deposits, which pay out a fixed rate of interest every year, have gone down. In fact, a fixed deposit paying an interest of 8-9% per year currently has a negative real rate of return in an environment where the consumer price inflation is greater than 9%. “Much of the financial savings of the household sector are in the form of bank deposits (around 30 per cent in the 2000s)..These were also the years when the real rate of interest was generally declining,” the Economic Survey pointed out.
In such an environment a lot of money has gone into gold and real estate which had a prospect of giving higher returns. As the Economic Survey pointed out “The last three years have seen a substantial rise in gold imports (the value of gold imports increased nine times between January 2008 and October 2012)…Gold imports are positively correlated with inflation.” High inflation reduces the ‘real’ return adjusted for inflation on other financial instruments and leads to people buying gold.
Given that a lot of savings have gone into gold and real estate, this has pulled down overall financial savings. As financial savings have fallen dramatically the interest rates on loans has been high for the last few years. In fact this is one reason why Indian businesses have been borrowing a lot of money abroad rather in India over the last few years. As the Business Standard reports “Beginning 2004, the central bank(i.e. RBI) has approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years.”
Both gold and external borrowings have added to India’s dollar problem. India produces very little gold. Hence, almost all the gold that is consumed in the country is imported. Gold is bought and sold in dollars internationally. And every time an Indian importer buys gold, dollars are needed. This pushes up the demand for dollars in the market and puts pressure on the rupee. Gold imports are one reason why the rupee has lost value against the dollar through much of this year.
The finance minister P Chidambaram has been asking people time and again not to buy gold, without addressing the basic problem of “inflation”. Gold is finally just a symptom of the problem i.e. inflation. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy,” the Economic Survey pointed out.
As far as foreign borrowings by Indian businesses are concerned, they need to repaid. To do this, Indian businesses will have to sell rupees and buy dollars, and this will push up the demand for dollars and put further pressure on the rupee. As the Business Standard points out “Much of this external commercial borrowing will come up for repayment this financial year, putting further pressure on the rupee.”
So financial savings going down due to inflation has created several problems for the country. Another reason for the financial savings being hit is the tremendous mis-selling of insurance by insurance companies. The RBI report says that the “credibility of the financial institutions” has been hit “in the wake of mis-selling of products and financial frauds”. The government hasn’t been able to do much on this front as well.
The article originally appeared on www.firstpost.com on June 28, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)