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The basic issue

There has been a sharp reduction in the household net financial savings rate in 2022-23, leading to an overall decline in the financial savings rate. The savings rate refers to the amount of savings as a percentage of GDP, while household savings measure the change in financial assets during a period. Financial savings include bank deposits, savings in mutual funds, pension funds, and payments for consumer durables. The gross financial savings to GDP ratio declined by 3 percentage points, from 7.3% to 5.3% in 2022-23. This sudden fall in household savings has become a cause for concern.

Some theoretical issues

Neo-classical economic theorists, such as Alfred Marshall and Arthur Pigou, argue that a mature capitalist economy will always maintain full employment, meaning no economic inputs remain unutilized. If some inputs are underutilized, economic activity will adjust until price fluctuations balance supply and demand, achieving general equilibrium. In this state, the supply of savings will equal the demand for investment. Excess savings will move to economies where investment demand exceeds savings supply, and vice versa.

In India, the question arises: can a lower household savings rate create investment problems, or will it raise interest rates and hinder economic growth? The neo-classical view that savings equal investment is not applicable to India. Instead, Keynesian theory is more relevant. John Maynard Keynes argued that an economy’s output and investment are determined by its total effective demand. Investment demand is driven by the expected sale of goods and services, not by the amount of savings. Therefore, India’s falling household savings rate should be analyzed using Keynesian principles.

Reasons and consequences of falling household savings rate

According to Ambor Ghosh, an economics professor at Jadavpur University, the fall in household savings may be due to high inflation, especially in essential items. Rising prices consume a significant portion of dis-posable income, forcing households to spend more to maintain their standard of living, which can reduce savings. This decrease in savings could lower GDP as household purchasing power declines.

Economics teachers Zico Dasgupta and Srinivas Raghavendra from Azim Premji University recently analyzed this phenomenon (The Hindu, April 21, 2024). They believe that if household incomes rise faster than interest payments, there will be no problem, but this is unlikely. Prolonged inflation could increase consumer vulnerability. If borrowers cannot repay higher debts, banks and non-bank institutions may face balance sheet issues. Dasgupta and Raghavendra also warn that using higher interest rates to combat inflation by reducing macroeconomic output and employment could leave households with increasing debt. Higher interest rates can negatively impact household consumption and aggregate demand.

The recent report of Goldman Sachs

A recent Goldman Sachs report (May 22, 2024) noted that net household savings likely rose to 6% in FY 2023-24 from 5.1% the previous year due to faster household deposit growth. The report highlighted that gross financial savings are expected to outpace the increase in household financial liabilities in FY 2024. It stated, “This increase in net financial savings is mainly driven by higher gross financial savings of 12.5% of GDP, compared to 11% of GDP in FY 2023. This has been possible due to higher bank deposit growth.”

The interplay between household savings, inflation, and interest rates presents a complex challenge for India’s economic development, requiring careful policy consideration to ensure sustainable growth.