Recently released data from the Central Statistical Organisation (CSO) indicates that India's savings rates continue to decline, and the deterioration is the greatest in financial savings. The CSO data indicates that gross domestic savings in 2011-12 fell to 30.8 per cent from a level of 34 per cent in 2010-11. This number compares with a peak savings rate of 36.8 per cent achieved in 2007-08. Back then, most observers were convinced that Indian savings rates were headed to over 40 per cent, which with a current account deficit of two per cent and thus, an investment rate of at least 42 per cent, would more or less guarantee us 10 per cent gross domestic product (GDP) growth. The maths was all so simple: 42 per cent investment rate (40 + 2), with an ICOR (incremental capital output ratio) of four, delivered 10 per cent GDP growth - and that too for an extended period. We were going to follow China down the same path it had traversed over the last three decades. If only life were so simple.
Unfortunately, instead of accelerating to over 40 per cent, as the CSO data shows, we have regressed and our savings rates have actually fallen. Given the state of the economy and profits, it is very likely that the savings ratio will dip further in 2012-13. If that were to happen, then we are going to be close to the savings rates of 29-30 per cent last seen in 2003-04 (when the whole bull run for India began). Indeed, far from the forecast investment rates of 40 per cent-plus, the current investment rate according to the CSO data was about 35 per cent.
The decline of 3.2 percentage points in the savings rate in 2011-12 compared to 2010-11 was spread across all components. Household savings fell from 23.5 per cent to 22.3 per cent, public sector savings fell from 2.6 per cent to 1.3 per cent and corporate savings fell from 7.9 per cent to 7.2 per cent. The problem, therefore, is not isolated to one specific segment.
The bigger worry, however, is not the overall broad savings number, even though the decline is not healthy for an economy at our state of growth or development. The bigger concern is the sharp fall in financial savings of the household sector, which have now fallen to eight per cent of GDP from a level of 12 per cent as recently as 2009-10. Naturally, this fall in financial savings has been accompanied by a rise in the share of household savings in physical assets to 14.3 per cent (was 13.1 per cent in 2010-11).
This drop in the ratio of financial savings, while easily explainable given high inflation, negative real returns on deposits and strong returns available on gold and property, is nonetheless a big negative on many fronts.
First, while we do not feel the impact of this reduction in the pool of financial savings today given the very constrained demand for credit from corporate India, as soon as the investment cycle turns, rates will spike. It is unlikely that the government will reduce its draw on this limited pool of financial savings, and we cannot support an investment-driven growth cycle as well as this level of government borrowings. Unless our pool of financial savings increases materially (both in absolute terms and as a percentage of GDP), we will force even more of our companies to move overseas to raise borrowings. We have already relaxed our debt market limits to allow up to $75 billion of foreign capital, increasing the pool of accessible savings. These limits will only keep rising. By raising them, we are essentially integrating our markets much more strongly with global drivers. There is no free lunch; we will have to now subject ourselves to the discipline of global investors and their attitudes towards and confidence in India.
Second, within this shrinking pool of household financial savings, the portion earmarked for capital markets and equities has shrunk even more. If you talk to anyone in India, either on the mutual fund side or even insurance players, there is real frustration on the seemingly unending stream of redemptions from equity products. Just look at the data over the past year - huge inflows from foreign institutional investors on a continuing basis, but met with large selling from domestic investors. There is also a continuous closing of demat accounts since retail investors continue to exit our capital markets. This has effectively left our capital markets entirely dependent on foreigners. India is now considered to be a huge leveraged bet on global liquidity and risk appetite. God forbid we have another 2008-type crisis and $8-10 billion exit, our market will be on its knees.
To sustain a market up-move, at some stage domestic investors will have to come back into equities. Today, they see no reason to do so given the returns they have generated in both real estate and gold over the last five years. While this is typical backward-looking thinking, it is tough to argue with an investor when he or she is convinced that property never goes down and will deliver 20 per cent returns forever. I would argue that to have a real sustained bull market in equities, property prices (especially in the top 20 cities) will have to see a bear market. It seems as if only then will money flow out of property speculation.
Our markets cannot be supported beyond a point only on foreign flows. To sustain their levels, domestic investors have to participate. Rising markets, all through last year,instead of sucking in the domestic investor, were used by them to exit. This has to change. The finance minister clearly understands this dynamic; I don't think he has any desire to keep travelling the world to canvas support to complete his disinvestment programme. Ideally, he should have no need to go beyond Mumbai. Hopefully, the finance minister will give some tax breaks for savings, moving into financial products or allowing equities to be used more broadly in retirement planning by individuals.
The Reserve Bank of India also has to balance the interests of domestic industry (calling for quick and substantial cuts in rates) and those of savers. A move to aggressively cut rates may further push savers out of financial assets. Even today, bankers are reluctant to cut deposit rates, since deposits are only growing at 13 per cent. A substantial reduction in lending rates looks tough, unless deposits start growing again. Unless the pool of financial savings can be significantly enhanced, deep rate cuts by lenders are just not possible.
Given our demographics and our culture, we have the ability to be a high-savings, high-growth economy. More of these savings have to move into financial products, or we have to find a way to unlock the huge pools of capital stuck in physical savings. This is an imperative we cannot back away from.