By Mr. Ajay Srinivasan, Chief Executive, Aditya Birla Management Corporation
Four years (2008) after the worst financial crisis in recent times, the economic situation in India continues to slip.
A couple of months ago, India posted the lowest GDP (Gross Domestic Production) growth of 5.3 per cent since the 2008 crisis and are most likely to achieve a 5 to 5.5% growth for the whole year - a far cry from the 7.3% growth expected at the start of the financial year.
Barely 18 months ago, we were growing at 8.4%.
Good Starting Point..!
A fair question at this point is whether our country India is experiencing a temporary hiccup or / something more fundamental and lasting.
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| Ajay Srinivasan, Aditya Birla Management Corporation |
A good starting point is to evaluate the drivers behind the 9 to 9.5% growth in the 2003 to 2007 period.
India faced a significant investment boom in the above mentioned period when investment or gross capital formation increased sharply from 22 % of GDP in 2001-02 to almost 38% of GDP in 2007-08.
To put this growth in context, the real gross capital formation grew at a 15.4% rate in FY06 to FY08 or, in other words, investment growth was responsible for almost 50% of the 9.5% GDP growth in the FY06 to FY08 period.
Real Gross Capital Formation ..!
On the other hand, real gross capital formation has grown at only 0.1% in the past 3 quarters. No wonder our GDP growth has slowed!
Investment drivers
Investments grew not only because of a number of demand-driven factors including robust corporate profits, capacity expansion to meet domestic demand and infrastructure development, especially power projects, but also because of a number of supply side measures such as increased infra lending by the banking sector & a sharp acceleration in India’s saving rate from 23% of GDP in FY02 to 37% of GDP in FY08.
Low Middle Income Country..!
Given India is still a low middle income country (with <$ 2,000 income per capita) with significant infrastructure needs, the demand drivers for capital formation are still strong. But the supply-side or capital available for investment is showing some disturbing trends.
Our country India is not different from other emerging economies in that most capital development is internally financed through domestic savings. Most emerging markets had savings rates higher than investment rates or / close to 80 to 90% of the investment rate in 2010.
Domestic savings have declined from 37% of GDP in FY08 to 32% of GDP in FY11.
In a capital-deficient nation like India, it is not difficult to see how a high investment rate & better infrastructure is critical in making sure that India’s potential growth rate remains high.
One can almost think of our saving rate as a driver of future growth & productivity levels.
Savings trends
Analysing the savings trends for the past ten (10) years, it is evident that household savings (as per cent of GDP) have been largely unchanged at 22 to 23% since 1999-2000.
On the other hand, both public & corporate savings have hit their 10 year highs in FY08 and have fallen since then.
Public Savings.!
Not surprisingly, a drop in public savings from 5% of GDP in FY08 to 1.7% of GDP in FY11 is the primary cause for the 5% drop in aggregate savings rate. The increase in the fiscal deficit from 2.5% in FY 08 to 4.9% in FY11 explains a big portion of the drop in public savings.
While private corporate savings have also dropped from 9.4 per cent in FY08 to 7.9 per cent in FY11, the drop is much less severe than the drop in public savings.
Even though the household savings rate has remained unchanged over the last 10 years, the recently released (Reserve Bank of India's (RBI) FY12 annual report has highlighted a disturbing trend in the composition of household savings.
The more productive component of household savings, namely, financial savings, which are in turn provided to users of capital and, thus, have a multiplier impact, have dropped to 1990 levels of 7.8% of GDP from 12.2% of GDP in 2010.
Small Savings & Equity Mutual Funds..!
The drop in net financial savings is largely a result of an absolute decline in small savings & equity mutual funds and lower growth in household’s holding of currency and life insurance funds.
If we look at the composition of financial savings over the years, we can see that in FY10, shares, debentures, equity MFs and life insurance products gave bank deposits serious competition.
In FY12, post regulatory changes and the external market, shares, mutual funds, insurance & debentures are de-growing while bank deposits have increased their share of financial savings.
Persistence of high inflation, with average inflation of 9% in 2011-2012, and thus low real rates on small-savings & deposits seems to have incentivised household savings into real assets such as gold and real estate.
Moreover, lacklustre equity market returns & regulatory changes in the past 2 years have resulted in a weak appetite for equity funds and Uint linked insurance plans (ULIPs).
How to Increase Savings..!
As discussed above, high government deficit is a big driver of the fall in savings and Investment rate and, thus, it is imperative that the Centre reigns in spending and stops crowding out private investment.
Moreover, Indian policy-makers need to insure that savers can earn adequate real returns in “productive” financial savings rather than turning to “non-productive” real assets such as gold.
And, finally, we need an environment where financial savings and investments are accessed & put into assets which, post- income tax, have the potential to beat inflation longer term, so that not only will we have our population being able to meet their future financial needs, but we will be able to channelise savings into the sectors that need money to grow.
The bottomline is, if we allow our investment rate to fall, we risk impairing our long-term potential growth rate.
A high savings rate is an important pre-requisite to return to the high growth era of 8% plus GDP growth.
The onus is on the Government to control fiscal spending & tame inflation to incentivise savings. It would be a shame if we convert the current cyclical slowdown into something more structural.
About the author..!
Mr. Ajay Srinivasan is Chief Executive (Financial Services) at Aditya Birla Management Corporation Pvt Ltd.
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