Syllabus
GS Paper 3 – Indian Economy (issues re: planning, mobilisation of resources, growth, development, employment); Inclusive growth and issues therein
Applications where to apply?
When asked about
– Household savings for economic growth
– Micro and macro economic linkages
– Prelims terms and concepts
Context
Household net financial savings to GDP ratio have declined due to increased borrowing and structural shifts rather than a mere change in savings pattern.
Source
The Hindu | Editorial dated 24th May 2024
Rising debt strains household savings
The drastic fall in the household net financial savings to GDP ratio during 2022-23, attributed to a higher borrowing to GDP ratio, has sparked a significant debate. While the Chief Economic Advisor (CEA) to the Government of India views this trend as a shift in the composition of household savings towards higher physical savings, there are counter arguments that the interpretation is inconsistent with broader economic trends and highlights structural shifts in the Indian economy.
Changes in Savings Pattern
The household savings to GDP ratio includes net financial savings, physical savings, and savings in gold and ornaments.
Data from 2022-23
- Net financial savings to GDP ratio declined by 2.5 percentage points.
- Physical savings to GDP ratio increased by only 0.3 percentage points.
- Household borrowing to GDP ratio increased by 2 percentage points.
- Gold savings to GDP ratio remained unchanged.
- Overall household savings to GDP ratio declined by 1.7 percentage points.
Reasons for Decline
- Shift in Savings Composition: The Chief Economic Advisor (CEA) interpreted the trend as a shift in the composition of household savings.
- Increased Borrowing for Physical Savings: According to the CEA, households are incurring greater borrowing or reducing their net financial savings not out of distress but to finance higher physical savings.
- This means that households are taking on more debt to invest in physical assets like real estate, durable goods, or infrastructure, which they believe will provide better returns or value over time.
However, a mere change in savings composition would keep the overall savings ratio unchanged. This has led to critical counter arguments like:
- Lower net financial savings to GDP or higher borrowing to GDP would be fully offset by a corresponding increase in the physical savings to GDP ratio.
- Post-COVID Economic Impact: households are taking on more debt not just to invest in physical assets but also to manage higher interest payments, which reflects financial distress
- Fisher Dynamics: In the post-COVID period, India has experienced a sharp rise in the ratio between nominal debt and nominal income, largely because income growth has not kept pace with rising interest rates.
| Fisher dynamics Named after economist Irving Fisher, describe the phenomenon where the ratio of debt to income rises due to changes in interest rates and nominal income growth rates. Specifically, if interest rates increase or income growth slows, the debt-income ratio escalates because households need to allocate a larger portion of their income to service their debt. |
Macroeconomic Solutions
To address these challenges, policymakers may need to set additional macroeconomic targets focused on stimulating and supporting household income growth.
- Reducing Debt burden: The first challenge is to decrease the gap between interest rates and income growth to prevent further increases in household debt burdens.
- Maintaining Demand: The second challenge is to prevent a reduction in aggregate demand.
- High debt and interest payment commitments can lead households to cut back on consumption, which could slow economic growth.
- This could help reduce financial distress and support sustained economic growth.
Conclusion
The debate around the fall in household net financial savings to GDP ratio highlights deeper structural issues within the Indian economy. It is essential to address the rising debt-income ratio and the resultant financial distress faced by households. Policymakers must focus on reducing the interest rate and income growth gap and supporting household income growth to ensure sustainable economic development.
Related Topic
The paradox of thrift
The paradox of thrift is an economic concept that suggests that while saving is generally good for individuals, if everyone increases their savings simultaneously during a recession, it can lead to a decrease in overall economic demand.
This collective reduction in spending can worsen the economic downturn, leading to lower levels of income, employment, and ultimately, lower overall savings in the economy.
- Individual Saving vs. Collective Impact: While it’s prudent for individuals to save money, if all individuals or households decide to save more and spend less, the aggregate demand in the economy falls.
- Decrease in Consumption: Reduced consumption leads to lower sales for businesses, which can result in decreased production, layoffs, and lower investment by companies.
- Economic Contraction: As businesses face reduced demand, they may cut back on operations, leading to higher unemployment and further reductions in income and spending.
- Lower Overall Savings: Ironically, the attempt to save more can lead to lower overall savings in the economy because the decrease in economic activity reduces income and, hence, the ability to save.
References
Related PYQ
Among several factors for India’s potential growth, savings rate is the most effective one. Do you agree? What are the other factors available for growth potential? [ UPSC Civil Services Exam – Mains 2017]
Practice Question
Discuss the recent decline in household net financial savings to GDP ratio in India. [150 words]