Indian Economic Development: An insight on savings and investment From 1950 to 2013

Introduction

The overall growth in India since independence has been largely enabled by the availability of domestic savings and investment, which have increased steadily over decades. The increasing extent of Household savings, Private investment and corporate growth coupled with a relative decline in the public investment has been the forerunner of India’s growth. Although our growth process continues to be dominated by domestic factors, however, the notion of growth driven by saving and investment can only be substantiated upon analysing the growth trends in the economy from the demise of colonial rule to the present day.

Growth trends Of India

             It is widely believed that the Indian economy witnessed near stagnation in real GDP growth till the late 1970s. The Indian economy continued its real GDP growth over each decade since Independence. Growth of manufacturing production,  was roughly constant at around 5.6- 5.9 per cent for 50 years after Independence, except for the 1970s. The two features of our growth history that are notable are: First, agricultural growth has been subject to large variation over the decades. The era of 1970's marked the severe deceleration in agricultural growth, followed by recovery in the 1980s, and a slowdown thereafter. Second, until the 1990s, a little note had been taken of growth in the services sector. Moreover, it is the continuing and consistent acceleration in growth in services over the decades, which accounts for the continuous acceleration in overall GDP growth. The slowdown of growth witnessed during the 1970s was reversed during the 1980s; the pick-up benefited from the initiation of some reform measures aimed at increasing domestic competitiveness. Since the early 1990s, growth impulses have appeared to have gathered further momentum in the aftermath of comprehensive reforms encompassing the various sectors of the economy. There was some loss of the growth momentum in the latter half of the 1990s, which coincided with the onset of the East Asian financial crisis, quality of fiscal adjustment etc. However, Since 2003-04, there has been a distinct strengthening of the growth momentum. Restructuring domestic industry, reduction in domestic interest rates, benign investment climate and commitment rules-based fiscal policy has led to the real GDP growth averaging close to 5% till 2013. The turning point from the "traditional" low growth to the modern high growth since the 1980s is clearly associated with the consistent trends of increasing domestic savings and investment over the decades. 

Saving and Investment trend

               Gross domestic savings have increased continuously from an average of 9.6 per cent of GDP during the 1950s to almost 35 per cent of GDP at present; over the same period, the domestic investment rate has also increased continuously from 10.8 per cent in the 1950s to close to 36 per cent by 2006-07. A very significant feature of these trends in savings and investment rates is that Indian economic growth has been financed predominantly by domestic savings. The recourse to foreign savings i.e. current account deficit – has been rather modest in the Indian growth process. The long-term upward trends in savings and investment have, however, been interspersed with phases of stagnation. In particular, during the 1980s, the inability of the Government revenues to keep pace with the growing expenditure resulted in widening of the overall resource gap. Accordingly, the public sector saving-investment gap, which averaged (-) 3.7 per cent of GDP during the period 1950-51 to 1979-80, widened sharply during the 1980s, culminating in a high of (-) 8.2 per cent of GDP in 1990-91. The resultant higher borrowing requirements of the public sector led the Government to tap financial surpluses of the household sector.

Financial Crisis of 1991

                 The growing fiscal imbalances of the 1980s spilled over to the external sector and were also reflected in inflationary pressures. Along with a repressive and weakening financial system, this rendered the growth process of the 1980s. The external imbalances were reflected in a large and unsustainable current account deficit, which reached 3.2 per cent of GDP in 1990-91. As the financing of such a large current account deficit through normal sources of finance became increasingly difficult, it resulted in an unprecedented external payments crisis in 1991 with the foreign currency assets dwindling to less than US $ 1 billion.   

Fiscal consolidation

  Following this the SLR reached a high of 38.5 per cent of NDTL in 1990 which was unable to meet the fiscal requirements. Thus the burden of financing the Government had also to be borne by the RBI, which led to high levels of monetised deficit.The RBI increased CRR to support the Central Government, however, the increase in CRR spilled over to inflation. High SLR and CRR along with the direction of credit to priority sectors at concessional interest rates resulted in higher lending rates and thereby crowded out credit to the private sector. This resulted in an imbalance in the economy.  In response to the balance of payments crisis, a program of macroeconomic stabilisation and structural adjustment was put in place. Fiscal consolidation constituted a major policy response to the macroeconomic crisis. Policies such as the buoyancy in the revenues accompanied by some reprioritisation of expenditure were implemented. The revenue augmenting strategy encompassed moderating the tax rates and broadening the tax base through expansion in the scope of taxes, specifically service tax, removal of exemptions, some improvement in tax administration. Reflecting these measures, the tax-GDP ratio of the Centre has steadily risen from 8.8 per cent in 2002-03 to 11.3 per cent in 2006-07 (RE) and 11.8 per cent in 2007-08 (BE). The entire increase in tax revenues was mainly on account of the buoyancy in direct taxes. On the expenditure front, while the total expenditure of the Centre declined from 16.8 per cent of GDP in 2002-03 to 14.1 per cent in 2006-07 (RE), the capital outlay rose from 1.2 per cent to 1.6 per cent of GDP. The movement in key deficit indicators reflects the progress made so far in fiscal consolidation. Fiscal deficit of the Centre and the States taken together has declined from 9.2 per cent of GDP in 2002-03 to 6.4 per cent in 2006-07.

Public Sector Savings

          The major component of public sector savings, i.e., savings of non-departmental undertakings, has, interestingly, exhibited a steady improvement since the 1970s and this process has continued during the reform period. Thus public sector enterprises have exhibited continued and steady improvement in their commercial functioning since the early 1990s. Consequently, since 2003-04 onwards, total public savings have turned positive again. The savings rate of the overall public sector improved from (-) 0.6 per cent of GDP in 2002-03 to 3.2 per cent of GDP in 2006-07. The public sector investment rate increased from 6.9 per cent of GDP in 2001- 02 to 7.8 per cent in 2006-07. Despite this increase, this sector’s saving-investment gap has narrowed down from 8.9 per cent of GDP to 4.5 per cent during 2001-2007, reflecting a turnaround in the public sector savings (which rose from (-) 2.0 per cent to 3.2 per cent) enabled by the implementation of the fiscal rules. 

Private Corporate Sector

          The reduced requirement by the Centre for meeting budgetary mismatches improved the availability of resources for the private sector. Furthermore, the corporate sector has responded to increased global competition by improving its productivity and efficiency through increased application of technology. The corporate tax rate was steadily reduced from 45 per cent in 1992-93 to 30 per cent by 2005-06. The peak rate of customs duty on non-agricultural goods were also reduced. Monetary policy controlled inflation leading to reduction in nominal interest rates. Financial restructuring of firms has also led to the reduction in overall debt equity ratios in the corporate sector adding to profitability. The profit after tax (PAT) to net worth ratio, after declining from 14.4 per cent in 1995-96 to 5.1 per cent in 2001-02, increased to 16.6 per cent 2005-06. There was a subsequent increase in retained profits, as the share of PAT, increased from 30.9 per cent in 2001-02 to 73.6 per cent in 2005-06. The improved corporate financial performance resulted in doubling of the private corporate sector saving rate (from 3.9 per cent in 2002-03 to 7.8 per cent in 2006-07), which has also contributed to the pick-up in the overall savings rate. From the long-term perspective, it is interesting to observe that the rate of savings of the private corporate sector has increased from around one percent in 1950s, 1.7 per cent in 1980s and 3.8 per cent in 1990s, to almost 8 per cent now. Higher retained profits along with availability of resources from the banking sector facilitated and the increased access to the domestic and international capital markets led to a sharp increase in the investment rate of the corporate sector from 5.7 per cent of GDP in 2002-03 to 14.5 per cent in 2006-07. Thus, despite the increased savings rate, the saving-investment gap of the corporate sector widened from 2.1 per cent of GDP in 2001-02 to 6.8 per cent in 2006-07.

Households

             A remarkable feature of the Indian macroeconomic story since independence has been the continuous rise in household savings over the decades. As might be expected, this rise has been characterised by continuing increases in financial savings as a proportion of GDP. The spread of the financial sector helped in mobilising household financial savings. Their financial liabilities did not grow correspondingly since there were few financial products available for household credit. This situation has changed in recent years with the introduction of new private sector banks, who introduced retail credit for housing and for consumer durables in large measure. The public sector banks have followed suit. Hence, while gross financial savings of the household sector have continued their upward trajectory in the recent few years, households’ financial liabilities have also been increased rapidly. Gross financial savings grew from 13.8 per cent of GDP in 2004-05 to 18.3 per cent in 2006-07, while their financial liabilities rose from 3.8 per cent of GDP during 2004-05 to 6.8 per cent during 2006-07. The ongoing financial deepening is facilitating larger access of bank credit for the households. As a result, household financial savings (net) have increased only marginally in the current decade – from 10.9 per cent of GDP to 11.3 per cent during 2001-2007. On the other hand, with increased availability of housing finance, household sector’s investment rate (physical savings) increased from 10.5 per cent in 1997-2003 to 12.7 per cent in 2003-07. Thus, the widening of S-I gaps of the public and private corporate sectors combined was partly financed from household financial savings and partly by foreign savings. This is reflected in a widening of the current account deficit from 0.4 per cent of GDP in 2003-04 to 1.1 per cent of GDP in 2006-07. Reflecting the improved finances at the sectoral levels, the gross domestic saving rate, after varying in the range of around 21-24 per cent of GDP during the 1990s, has steadily risen to 34.8 per cent in 2006-07. The investment rate also picked-up significantly from 22.9 per cent of GDP in 2001-02 to 35.9 per cent in 2006-07. With the ICOR hovering around 4, the real GDP growth accelerated from 3.8 per cent in 2002-03 to 9.6 per cent in 2006-07. Not only has there been a consistent upward trend in India’s investment rate since the 1950s, there is evidence that capital has been employed productively. Barring the decade of the 1970s, the incremental capital output ratio (ICOR) has hovered around 4. There are some signs of improvement in domestic productivity in the post-reforms period. Cross- country comparison indicates that ICOR has been amongst the lowest in India. This is especially true of the period since the 1980s onwards. Various reform measures aimed at increasing the competitiveness appear to be having the desired impact on the productivity of the Indian economy.

Trends in saving and investment from 2008 to 2013

        The domestic saving rate rose from 32.4 per cent of GDP in 2004-05 to reach a peak of 36.8 per cent in 2007-08.Thereafter, it started declining and touched a low of 30.1 per cent in 2012-13. During the later period, there was a perceptible decline in the saving of the public sector.It fell from 5.0 per cent of GDP to 1.2 per cent. Within the public sector, saving of government administration fell from 0.5 per cent in 2007-08 to (–) 1.9 per cent in 2012-13. This was a period marked by high revenue deficit.The saving of the private corporate sector fell from 9.4 per cent to 7.1 per cent.However, the saving of the household sector showed only a minor change, declining from 22.4 per cent in 2007-08 to 21.9 per cent in 2012-13. But the composition of household sector saving underwent a big change.Saving in financial assets declined from 11.6 per cent to 7.1 percent while saving in physical assets increased from 10.8 per cent to 14.8 per cent. Thus, while in the first four years beginning 2004-05, the saving rate rose sharply, subsequently it started declining, particularly because of a sharp decline in public sector and corporate saving.However, it needs to be borne in mind even after such a decline the saving rate in 2012-13 was high.

        Gross capital formation which is the technical term used for investment comprises of three elements, Gross Fixed Capital Formation, Change in Stocks and Valuables.The gross capital formation rate after reaching a peak of 38 per cent in 2007-08 declined to 34.7 per cent in 2012-13. The decline in investment rate during the period is less than the decline in the saving rate because of the rise in the current account deficit which amounts to a net inflow of resource from abroad. Focusing our attention on gross fixed capital formation rate, it rose from 28.7 per cent of GDP in 2004-05 to 32.9 per cent in 2007-08 and then declined to 30.4 per cent in 2012-13.The public sector gross fixed capital formation rose from 6.9 per cent in 2004-05 to reach a peak of 8.0 per cent in 2007-08 and it stood at 7.8 per cent in 2012-13. This decline was negligible.The household sector investment continued to rise throughout the period. In fact the peak was reached in 2011-12 at 15.2 per cent. In 2012-13, it stood at 14.1 per cent.However, the private corporate sector investment rate rose from 9.1 per cent in 2004-05 and reached a peak of 14.3 per cent in 2007-08 and thereafter declined sharply to 8.5 per cent in 2012-13.Thus through the decade, public sector investment rate and the household sector investment rate remained unchanged at a high level. It was only the corporate sector investment which traced a path similar to the growth performance of rising sharply in the first four years and thereafter declining slowly but falling very steeply in 2012-13

Financial Sector Reforms and FRBM

                 Financial sector reforms, initiated in the early 1990s, encompassed the introduction of auctions in Government securities, deregulation of interest rates and a reduction in statutory pre- emption of institutional resources by the Government was carried forward with the phasing out of the system of automatic monetisation of fiscal deficits from 1997-98. These measures along with developments in the Government securities market, by making the yield market- determined, formed the backbone of financial market reforms. Apart from making the interest rates largely market determined, reforms included a market-determined exchange rate (though accompanied by RBI forex intervention), current account convertibility and substantial capital account liberalisation. This process was further strengthened through the implementation of the FRBM Act, 2003, under which the Central Government targets to eliminate the revenue deficit and reduce its fiscal deficit to 3 per cent of GDP by 2008-09 and the Reserve Bank was prohibited from participating in the primary government securities market from April 2006. Overall, these reforms have led to better price discovery in both interest rates and exchange rate, thereby contributing to the overall efficiency in financial intermediation.

The macroeconomic review of the Indian economy does suggest moving to a higher growth path in recent years, supported by investment, savings and improvement in productivity.

Challenges 

However, there are few challenges which need to be met for a continuum of  growth rate in the Indian economy. First, Indian economic growth has been largely enabled by the availability of domestic savings. The continued acceleration of its growth over the decades has been accompanied by a sustained increase in the level of domestic savings, expressed as a proportion of GDP. Moreover, the efficiency of resource use has been high with a long term ICOR of around 4, which is comparable to achieving the best countries in the world. Hence, in order to achieve 10 per cent+ growth, we will need to encourage the continuation of growth in savings in each of the sectors: households, private corporate sector, public corporate sector and the government. 

Second, the recent acceleration in growth has been enabled by a surge in private sector investment and corporate growth. This, in turn, has become possible with the improvement in fiscal performance, reducing the public sector’s draft on private savings, thereby releasing resources to be utilised by the private sector. For the growth momentum to be sustained, it will therefore be necessary to continue the drive for fiscal prudence at both the central and state government levels. 

Third, the generation of resources by the private corporate sector through enhancement of their own savings has been assisted greatly by the reduction in nominal interest rates, which has become possible through a sustained reduction in inflation brought by monetary policy. Indian inflation needs to be brought down further. It is only when there is a further secular reduction in inflation and inflation expectations over the medium term that Indian interest rates can approach international levels on a consistent basis. Hence, it is necessary for us to improve our understanding of the structure of inflation in India

Fourth, whereas the fiscal correction has gained a credible momentum in recent years, some of it has been achieved by reduction in public investment. Whereas a desirable shift has taken place from public to private investment in sectors essentially producing private goods and services, and there is a move toward public private partnerships in those which have both public good and private good aspects, it is necessary to recognise that public investment is essential in sectors producing public services. 

Fifth, a major success story in the Indian reform process has been the gradual opening of the economy. On the one hand, trade liberalisation and tariff reforms have provided increased access to Indian companies to the best inputs available globally at almost world prices. On the other hand, the gradual opening has enabled Indian companies to adjust adequately to be able to compete in world markets and with imports in the domestic economy. The performance of the corporate sector in both output growth and profit growth in 

Refrence:
C Rangarajan
 http://www.thehindubusinessline.com/opinion/growth-and-investment-the-interlinks/article6405448.ece
Rakesh Mohan
http://www.bis.org/review/r080218c.pdf