1. Indian Economy: The Curious Case of Household Savings-Investment Gap
The recent debate between former Federal Reserve Chairman Ben Bernanke and former US Treasury
Secretary Lawrence Summers has rekindled interest in the topic of “Global Savings Glut”. The term was
first coined by Bernanke in his 2005 speech, where he argued that a significant increase in the global
supply of savings, emanating in large part from China and other emerging markets (EMs), had resulted in
both an increase in the US current account deficit as well as the relatively low levels of global long-term
real interest rates.
We know than an economy’s current account balance is a reflection of its savings and investment
behaviour. A country with a current account surplus is saving more than it is investing domestically and
hence is a net provider of capital in international capital markets. By the same logic, a country with a
current account deficit is a net borrower of capital in the global financial markets.
Till the 1990s, most EMs were net importers of capital. But after a series of financial shocks that rocked
them, a number of EMs were forced into new strategies of growth that involved shifting from being net
importers of financial capital to being net exporters. This is clearly visible in Exhibit 1 by the large current
account surpluses which EMs started running since early 2000.
The importance of generating greater savings and its channelization into productive investments in
order to achieve high and sustainable levels of economic growth cannot be underestimated. It is
therefore no coincidence that on the back of an increasing in savings rate, EMs have been the primary
drivers of global growth since 2000. However, it is interesting to observe that since 2010, EMs
collectively have once again started running current account deficits, reflecting decling national savings
rate. In fact, at an aggregate EM level, the savings rate peaked around 2007 and in many countries like
Brazil, South Africa and Turkey, they are now at dangerously low levels. Consequently, the decline in
savings rate along with falling productivity has meant that in the last 3-4 years, the alpha of EM growth
over developed economies (DMs) has significantly come down.
-1.0%
-0.8%
-0.6%
-0.4%
-0.2%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
2016
2019
Advanced Economies Emerging Markets
OPEC
IMF
Estimates
Source: IMF Economic Outlook
Exhibit 1: Current Account Balance (% of World GDP)

2. Like most EMs, India too has witnessed a precipitous decline in its savings rate in recent years.
Supported by favourable demographics, India’s domestic savings rate started rising from the late 1980s.
It increased from an average of 18.6% (as a % of GDP) during 1980-1990 to 23% during 1990-2000. It
picked up even further in the last decade, reaching a high of 36.8% in FY08. Consequently, India’s
potential growth also accelerated sharply during this period. However, post the crisis, the savings rate
started to show a declining trend, eventually falling to a 10-year low of 30.6% in FY14.
Historically, Indian households have not only been the largest providers of capital (savings-investment
gap positive) to the corporate and conolidated public sector (savings-investment gap negative), but their
savings behaviour has also tended to exhibit remarkable stability. In other words, the cyclicality in the
overall savings-investment gap of the economy and thus the current account has generally come from
the corporate and public sector rather than households. It is perhaps because of this reason that these
two sectors (the public sector in particular) have often been chided during periods of high current
account deficits while the household sector has often escaped being censured.
However, it is the households as an entity who deserve much of the criticism for the increased levels of
external sector vulnerability in recent years. As Exhibit 2 shows, household savings-investment gap
climbed up steadily from 9.9% in FY01 to a peak of 12.0% in FY10, but thereafter has experienced a free
fall. In fact, it is currently reeling at levels last seen during the late 1980s. But this is hardly the complete
picture. This is because the aggregate savings-investment gap in Exhibit 2 does not add upto the current
account balance. This is due to the fact that the category “valuables” is not included in the gross capital
formation of any of the three sectors (as it is difficult to locate the end user of the item) and is instead
reported as a separate category. If we assume that households are the primary end users of “valuables”
and adjust household gross capital formation accordingly, then the decline in the household savings-
investment gap looks far more ominous (Exhibit 3).
Household
(1)
Private
Corporate Sector
(2)
Public
Sector
(3)
Aggregate
(1+2+3)
2000-01 9.9% -1.2% -8.5% 0.2%
2001-02 10.5% -1.9% -8.8% -0.1%
2002-03 10.0% -1.8% -6.7% 1.5%
2003-04 11.0% -2.0% -5.3% 3.7%
2004-05 10.1% -3.8% -5.1% 1.2%
2005-06 11.9% -6.1% -5.5% 0.3%
2006-07 11.3% -6.6% -4.7% -0.1%
2007-08 11.6% -7.9% -3.9% -0.1%
2008-09 10.1% -3.9% -8.5% -2.2%
2009-10 12.0% -3.8% -9.0% -0.8%
2010-11 9.9% -4.8% -5.8% -0.8%
2011-12 7.7% -3.6% -6.2% -2.2%
2012-13 7.3% -3.5% -5.5% -1.7%
2013-14 7.5% -1.7% -6.4% -0.6%
Exhibit 2: Savings-Investment Gap across the Three Sectors (% of GDP)
Source: CMIE database
FY12-FY14 numbers based on new gdp series

3. Evidently, this aberration in household behavior has had some series implications for the macro
economy:
1. When households purchase gold, it often comes at the cost of a financial asset and since gold is
an imported commodity, there is a permanent leakage of a potential financial saving from the
domestic economy. If instead of buying gold, the household exchanges its cash for a financial
asset then a) financial resources remain within the economy and b) the asset forms a part of
domestic savings and to that extent enhances domestic capital formation. Clearly, this
substitution of financial savings towards gold as well as real estate by households in recent years
has shaved off a few additional basis points from our potential growth. This is an important but
a rather under-appreciated fact
2. Increased household investments have not only resulted in a reduction in capital availability to
the private sector, but the economy’s capital productivity too has suffered (reflected in rising
ICOR). This is because private sector investments tend to be far more productive and tend to
have a much higher multiplier effect on the economy as compared to household sector. Though
difficult to quantify precisely, the dent in productivity has further impacted potential growth
3. The reduced capital availability to the private sector has caused domestic liquidity conditions to
remain extremely tight in the last few years, leading to over reliance on foreign savings, despite
subdued levels of private investments. While this over dependence has come at a time when
foreign liquidity has been in surplus mode, going forward, given the transient nature of this
liquidity, the global environment may not continue to remain as supportive
Households
(1)
Private Corporate
Sector
(2)
Public Sector
(3)
Aggregate
(1+2+3)
Errors &
Ommissions
(4)
Current Account
Balance
(1+2+3+4)
2000-01 9.2% -1.2% -8.5% -0.4% -0.1% -0.6%
2001-02 9.9% -1.9% -8.8% -0.7% 1.4% 0.7%
2002-03 9.5% -1.8% -6.7% 0.9% 0.3% 1.2%
2003-04 10.2% -2.0% -5.3% 2.9% -0.6% 2.3%
2004-05 8.8% -3.8% -5.1% 0.0% -0.3% -0.3%
2005-06 10.7% -6.1% -5.5% -0.8% -0.3% -1.2%
2006-07 10.1% -6.6% -4.7% -1.3% 0.3% -1.0%
2007-08 10.6% -7.9% -3.9% -1.2% -0.1% -1.3%
2008-09 8.9% -3.9% -8.5% -3.5% 1.2% -2.3%
2009-10 10.2% -3.8% -9.0% -2.6% -0.2% -2.8%
2010-11 7.8% -4.8% -5.8% -2.8% 0.1% -2.8%
2011-12 4.8% -3.6% -6.2% -5.0% 0.8% -4.2%
2012-13 4.6% -3.5% -5.5% -4.4% -0.4% -4.8%
2013-14 6.2% -1.7% -6.4% -1.9% 0.2% -1.7%
Exhibit 3: Savings-Investment Gap across the Three Sectors Adjusted for Valuables (% of GDP)
Source: CMIE database
FY12-FY14 numbers based on new gdp series

4. While it is far easier to penalize the public or the private corporate sector for their profligacy, there is
hardly any solid mechanism to regulate/alter household behavior. However, our view is that the damage
to the output gap due to aberration in household behavior has been so large, that the recovery (which is
already underway) is also likely to be much quicker. While we do not expect the headline household
savings rate to improve much in the near term, we believe that the savings-investment gap will continue
to show a marked improvement going forward. This is because while the headline savings rate is a
function of income, the allocation of savings into financial and physical assets is a function of relative
returns. Thus, with real income growth continuing to remain muted, the recovery in the headline savings
is likely to be very gradual. On the other hand, with more and more money gravitating from gold and
real estate and with inflation remaining constrained due to structural and cyclical reasons, households
investments is likely to moderate significantly, leading to a large positive savings-investment gap.
So what should be the way forward for policymakers? We believe that monetary authorities should be
more aggressive in cutting interest rates because of two factors:
1. Even though headline savings is unlikely to meaningfully pick up soon, the slack creation process
(rising savings-investment gap, falling credit-deposit ratio, falling inflation) is moving reasonably
quickly. In other words, the balance sheets of all stakeholders are showing signs of
improvement. Since potential growth is a direct function of strong balance sheets, it implies
that a recovery in potential growth is also underway. However, balance sheet repair still has
some way to go and this is unlikely to be possible without an accomodative monetary policy
2. Globally, the fear of deflation has led to an extraordinary monetary policy response in recent
years by the world’s major central banks. In fact, six years post the crisis, central banks around
the world (led by ECB and BoJ) continue to provide monetary support in some way or the other.
While deflation has become the consensus trade, potential growth in all major economies
continue to head lower, led by a collapse in labour and capital productivity. A fall in potential
output means that the world economy, especially the US, is operating much closer to potential
than most realize. This in turn implies that the need for unwinding of this ultra accomodative
monetary policy is likely to arise sooner rather than later. India, therefore, only has a small
window before global liquidity conditions turn unfavourable. Thus, In order to efficiently avail
this window, it is imperative for policy makers, especially the monetary authorities to provide
full support to the economy, so as to strengthen the domestic macroeconomic profile and
thereby reduce dependence on foreign liquidity.
To conclude, the Indian economy has undergone significant macro-rebalancing in the last 18 months.
Domestically, a number of imbalances which had creeped up is now showing signs of reversal. The
global environment also remains supportive, atleast as of now. In such an environment, the RBI has
adopted inflation targeting as its priority number one. Considering that a) the drivers of inflation could
be very different from rates/liquidity and b) balance sheets still need support and time to recover, the
urgency of implementation of a CPI based inflation targeting regime may not have been apt. Though
there is never a right time to swallow a bitter pill, the current environment warrants that growth gets
the attention it deserves.