In recent times there has been a significant decline in savings in India. There has been several reasons for such a decline, the notable being the fact that real interest rates have stayed negative for 21 consecutive months.
We however, believe, negative interest rates may not be the only factor in such. Interestingly, in economic literature, an increase in real interest rates is postulated to have an ambiguous effect on savings because of a positive substitution effect towards future consumption and a negative income effect due to increased real returns on saved wealth.
In the Indian context, studies show that the substitution effect of real interest rate is more than the income effect leading to overall negative impact of higher interest rates to savings rates.
However, the actual coefficients are relatively small (ranging from 0.1 to 0.3), suggesting a change of as much as 3% to 10% in real deposit rates will be needed to change savings rate by 1%.
We however believe if RBI leaves the rates unchanged, the real rates would reach as high as 4.6% during Nov-14 by taking CPI as proxy and 8.1% if WPI is taken as proxy.
This will be significantly higher than the desired real interest rate at 2%. We however believe that the launch of Pradhan Mantri Jan Dhan Yojana (PMJDY) will lead to better access to banking and will promote private savings in a developing country like India.
This apart, an increase in optional contributions to the PPF will still encourage Indians to save more in order to meet their expected retirement benefits.
This will be also enabled by the significant increase in life expectancy in India in recent years (life expectancy at retirement is now 82 years).
Indian households therefore necessarily have a stronger bequest motive so that a positive effect of anticipated retirement benefits can be expected. All in all, an increase in financial savings may be expected because of the recent Government changes.
By Dr. Soumya Kanti Ghosh, Chief Economic Adviser, Economic Research Department, State Bank of India