The determinants of household savings in India

The Union Budget aims to usher in a major reform in the personal income tax structure in India. It has made a beginning by introducing two tax slabs, one with exemptions and the other without. The government has also made it clear it aspires to eventually move towards a clutter-free simplified tax regime. While such a move is appreciated, it comes against declining household financial savings. Household financial liabilities have jumped Rs 3 trillion for the two-year period ended FY19 with net financial savings declining by Rs 80,000 crore in FY19 and it might have declined further in FY20. Against this background, it is important to understand the determinants of household savings in India in terms of macroeconomic and qualitative factors/incentivisation. That is because we require an estimated Rs 568 trillion in domestic investment during FY20-25, of which Rs 102 trillion must go into infrastructure alone. The mobilisation of household savings is a prerequisite to enable that. 

The Budget postulates a revenue foregone of Rs 40,000 crore if all taxpayers shift to the new tax regime. Assuming a marginal propensity to consume of 0.7, this should result in a consumption boost of Rs 1.33 trillion. However, this is based on the assumption that everyone will migrate to the new regime. 

To understand this in greater detail, based on the income tax calculator provided by the government post the an­nouncement of the Budget, we estimated the tax liabilities by just considering Rs 1.5 lakh and standard deduction, but assuming no housing loan exemptions whatsoever for any taxpayer. The results show that people with income over Rs 10 lakh stand to gain in the new tax regime. Now juxtapose the tax savings with the distribution of people having taxable income up to Rs 10 lakh — at Rs 74.9 lakh. Thus, the total consumption boost will be Rs 15,600 X 74.9 lakh = Rs 11,700 crore. This implies around 8 per cent could shift to the new tax regime. (Rs 3,510 crore revenue loss to the government against Rs 40,000 crore budgeted)

Interestingly, people in the lower income slabs are unable to take incentives (different from not taking incentives) like housing loan exemptions as they might be in the unorganised sector with low compensation. For the record, the prices of low-end house in India are at least 29 times higher than the per capita income (in the US the figure is 10 per cent). 

We also need to understand the typical determinants of household savings in India as this can give a complete picture of the impact of the proposed tax structure on such savings. As discussed earlier, household savings in India are a function of macroeconomic as well as qualitative factors. An analysis of over five decades of data (Ghosh & Nath, forthcoming paper) indicate that per capita real income, dependency ratio, inflation, real interest rate and access to banking are the most important of household saving rates in India. As people earn more in real terms, they tend to save more. Similarly, as the number of bank branches increases, households tend to save more.

As the rate of inflation increases, households in India insisting on maintaining a certain standard of living dis-save in order to bear the additional nominal expenses. Results also show that in the long run a higher dependency rate increase savings. It is possible that as parents care more about the quality of life for children, they save more in anticipation of increased future expenses on children. Also, a heavier burden of older family members may make the working age population aware of their future needs and requirements. People nowadays tend to have longer retired lives. So they may save more. With respect to the real interest rate, as it increases, the prospect of higher lifetime income persuades them to increase their current consumption and to reduce saving. 

However, these are macroeconomic factors. In a 2015 study (Ghosh and Ghosh, Business Standard, December 28, 2015) had found that soon after the Rs 50,000 increase in PPF was notified in August 2014, the incremental deposit amount had nearly tripled over the August 2014 deposit level for a sample of accounts. State-wise data had shown that Bihar, Uttar Pradesh, West Bengal etc each had a sizeable rural population that were, on an average, investing a significant amount in PPF. 

Interestingly, when we had looked at age-wise distribution in PPF investments before and after 2014, we found that investors in the 56-plus age group increased after 2014, with some investors among them being 75-plus. It was further observed that those who were at the lowest quantile of income distribution were craving to invest more by stretching the number of PPF payments in a year. For people with higher income, the objective was more towards saving tax. Clearly, the incentive to invest is a crucial factor impacting household savings in India. 

In the end, while the proposed changes in tax laws are applauded it is not clear how household savings will move in India in the future. It is also true that Indian middle-class investors, accounting for at least 30 per cent of our population, are smart enough to take decisions on their own, as India is the only country to score more than 7.3 against the global average of 5.9 in the Aegon Retirement Readiness Index. However, incentives do matter in our society as we don’t have a social security system or retirement benefits for our citizens. 

To conclude, if the tax proposals are any indication, the Budget seems to have a clear imprint of the nudge theory in behavioural economics propounded by Nobel Laureate Richard Thaler in 2008. The nudge theory propounds a relatively subtle policy shift to encourage people to make decisions in their broad self-interest — and it is not about penalising them financially. The use of the nudge theory also does not eliminate the need for vigorous democratic debate. For example, studies in the US, Chile, Mexico, De­n­ma­rk, and Sweden show that enrolling individuals automatically onto retirement plans and allowing them to opt out (rather than expecting them to opt in to existing systems) is a highly-effective way of in­creasing pension savings. Let us now set up a “Behavioural Insights Team” within the Ministry of Finance to have a permanent imprint of “nudge” in policy making. 

Soumya Kanti Ghosh is group chief economic advisor, SBI; Pulak Ghosh is professor, IIM Bangalore