A considerable share of Indians’ savings is held outside the financial system in the form of gold, real estate or cash, says a recent report released by PGIM India Mutual Fund. Such low level of financial savings mostly result from high inflation as private sector seeks to protect its assets from the inflation tax.
The report said that India’s large current account deficit implies that the higher domestic savings will need to underpin any increase in investment.
Countries typically depend on large pool of domestic savings to boost investment rather than widening their current account deficit, the report said.
The report shows that India has a very low financial savings compared to South Asian peers, which has limited the extent to which the inflation tax can be collected.
India’s low macroeconomic savings do not find themselves into financial saving i.e. loanable funds that can be intermediated between savers and borrowers.
As interest rates in India are still at a peak, it crowds out private sector borrowers and saddles public sector growth due to growing interest expenditures, which adds to public sector borrowing needs.
Savers in such an environment can be reluctant in lowering inflation expectation as they fret over the fact that government may rely on higher inflation to ease financial constraints.
Therefore, it is clear that higher savings cannot be achieved without fiscal consolidation and higher savings will likely have a positive knock-on effect on fiscal consolidation. During China’s successful growth spurt, its macroeconomic savings were high and the authorities kept inflation low and stable.
India’s inflation has been high and variable as government has relied on the inflation tax in the past, making many savers turn to non-financial savings. In addition, demonetization has likely lowered their trust in financial assets.
The report says that for India some critical tools for progress are now in place that could catalyze future growth.
Introduction of nationwide GST offers a significant revenue sources if it is simplified and loopholes are closed; similarly, the ongoing rationalization of subsidies could help trim spending.
Meanwhile, divestiture directed towards foreign investors could provide some interim relief as it could lower the stock of public debt.