The battles with RBI on this front have also not helped. Efforts to attract foreign investors will also not achieve too much until the financial sector and corporate balance sheets are cleaned up.
India has two fundamental problems in its pursuit of higher economic growth. First, it needs to increase investment. Second, it needs to increase savings. Both investment and savings have fallen as percentages of GDP, and are below the levels needed to support GDP growth of 8-10% a year. There is a counter argument that higher growth itself will rekindle animal spirits of investors, but I think the starting point has to be with creating prospects for better investment returns. The investment slowdown is related to the collapse of the preceding investment boom, which included too much corruption and, more generally, misallocation of capital. Until the overhang of bad assets is cleaned up, so that credit flows more freely again, investment will stagnate. The government has been trying, but perhaps not hard enough. The battles with RBI on this front have also not helped. Efforts to attract foreign investors will also not achieve too much until the financial sector and corporate balance sheets are cleaned up. Even then, the policy framework for investment has to improve, in terms of taxation, infrastructure, and stability.
The savings side is trickier, but also has the potential for plucking some low hanging fruit, with the right degree of policy attention. This is because the policy environment for savings in India is sub-optimal. This is particularly true of the household sector (including smaller firms in the Indian case), which has been the largest contributor to overall national savings. The other sources of savings—corporations, government and foreigners, are potentially important, but their determinants are more complicated, including whatever factors determine the investment climate, and the politics of government expenditure. Households, however, can be potentially reliable sources of savings.
There are three interrelated aspects of household saving where policies can be changed to make a difference. First, the level of household savings has fallen in recent years, despite high real (though not nominal) interest rates. Second, Indian households tend to put a relatively smaller proportion of their savings in financial assets, versus physical assets such as gold and real estate. Third, Indian households put relatively little of their financial savings into long term savings such as pensions and insurance products, versus bank accounts. All three factors result in a paucity of funds that can be intermediated into productive investment.
Tarun Ramadorai, who headed the RBI committee on household savings that reported in 2017, has pointed out that the tax incentives for long term savings through pensions are muddled and weak. He has made detailed proposals for clarity and simplicity in the design of pension schemes and the tax incentives that accompany them. This is about more than just “nudges,” and requires significant, but straightforward, policy changes. The government may be worried about possible losses of revenue through tax breaks, but this seems to be an area where the returns will justify any short term revenue hit.
Last year, Radhika Pandey, Ila Patnaik and Renuka Sane, in the India Policy Forum, provided a detailed empirical analysis of the impact of tax breaks on household financial savings, and found that such incentives must be carefully designed to avoid distortions between different types of financial saving. They also emphasised the need for more sensible regulations, giving insurance companies and pension funds more room to invest in assets other than government bonds. In brief, household savings have to be channelled efficiently to more productive investments.
The need for better channelling of household savings is driven home by a more recent analysis by Patnaik and Pandey, in an NIPFP working paper. Government policy on this front does not seem to be coherent or sufficiently evidence-based. Budget proposals often seem to be piecemeal and fragmented. Nevertheless, one can characterise this area as low-hanging fruit, because there is so much room for improvement. Despite the nuances of having different types of financial saving, with different types of institutions and regulations for collecting and channelling them, the underlying economic behaviours are not difficult to model and analyse.
A comprehensive, evidence-based policy approach to household financial savings will also help draw attention to institutional weaknesses in financial services and financial intermediation. It can be politically difficult to deal with such weaknesses without an overarching goal. Improving the level, composition and channelling of India’s household saving can provide the requisite framing for political feasibility of more fundamental institutional reforms, as well as reforms in tax policy and regulation for the financial sector. Institutional reforms here could include a greater role for private sector firms, more competition, and more effective use of digital technology. Patnaik and Pandey make all these points, and they just need more detailed modelling and simulation for evaluating policy options.
None of the above makes redundant the need for continued improvements in the climate for non-financial firms to do business, or to innovate, or to export. All the real aspects of producing and selling things in India are subject to hurdles that the government has the power to reduce or remove, if it decides it wants to be growth-promoting rather than rent-seeking or populist in its policy stance. But higher growth requires higher investment, and that will need more household financial saving, channelled to productive uses. This is an area that needs better policy attention than it has received.
(The author is Professor of Economics, University of California, Santa Cruz. Views are personal)