Nuances of household savings

Household (HH) savings in India consist of two parts — net financial savings (NFS) and physical savings. HH NFS is arrived at after deducting financial liabilities (known as annual borrowing) from gross financial savings (GFS). GFS includes seven key areas: Currencies; deposits (bank and non-bank); insurance; provident and pension funds (P&PF), including the public provident fund (PPF); shares and debentures (S&D); claims on government (small savings); and others. HH physical savings primarily constitute residential real estate (accounting for about two-thirds) and machinery and equipment (owned by producers within the HH sector).

Three key trends have emerged within HH savings in recent years: 1) within GFS, HHs have increased their exposure to riskier assets (eg S&D), and the contractual category (P&PF and government schemes, ie small savings) and shifted from bank deposits; 2) HH liabilities have mounted in the past few years; and 3) HHs have transitioned from financialisation of its savings by allocating a larger portion to physical assets.

I intend to discuss the economic implications of these developments and explain some nuances of HH savings.

It is a good idea to start by addressing the confusion surrounding the role of deposits within HH GFS. It is argued that even if an individual invests in mutual funds, insurance, or the PPF, almost all of it eventually ends up in someone’s (company’s) bank or non-bank deposits. If so, the change in the composition of GFS — away from deposits into S&D or insurance or P&PF — should not affect deposit growth.

This may sound correct, but it isn’t. Let’s say I purchase common stocks worth Rs 1,000 in XYZ company. It means my bank account is debited, leading to lower deposits, and my savings are shifted to “S&D”. Therefore, one must include other financial assets along with bank deposits to estimate GFS. There is, however, an interesting nuance. I can buy those stocks either from another individual (ie from the secondary market) or directly from the issuer (ie the primary market). In the former case, bank deposits and equity holdings of the two individuals will cancel each other out, and, thus, would not affect the composition of GFS. In the latter case, however, my bank account is debited, and XYZ’s bank account is credited. At the same time, I increase my holding of “S&D”, and XYZ’s liabilities (in the form of equity) also increase. Such shifts reflect either my unhappiness with lower interest rates on deposits or my strong confidence in the stock market. Speaking from the macro perspective, HH GFS may or may not rise in this case, depending on various other factors.

It is also important to note that although XYZ’s bank account was credited, it does not necessarily lead to higher savings because bank deposits are not considered when estimating corporate savings. Loosely speaking, they are estimated as the sum of retained earnings (ie profit af­ter tax after dividend) and the depreciation provision.

It also explains not all deposits are included in HH savings. Only HH deposits, which accounted for 62 per cent of bank deposits in FY23, are included in the calculation of HH GFS.

GFS must be adjusted with HH financial liabilities to arrive at HH NFS. Why? To avoid double counting and because not all HH deposits truly represent savings of HHs.

As explained above, HH savings include both financial and physical savings. Further, when an individual borrows, the lender credits the borrower’s bank account, leading to higher bank deposits. All loans, thus, become “deposits” first before they are used by the borrower. Such deposits, however, are not savings; and thus, they must be adjusted with borrowing to arrive at the true NFS.

The fact that HHs are shifting from bank deposits and increasing their leverage suggests they perceive interest rates to be low at this stage. Before you jump to the conclusion that I am recommending higher interest rates, let me remind you that HHs are only one of the participants in an economy, and the activities (borrowing, savings, investment, etc) of other participants (corporate and government) must be analysed before commenting on such policy decisions. My understanding suggests that there should not be a rate hike (or a rate cut) at this stage in India.

Lastly, we must note the rapid de-financialisation of HH savings. Physical savings accounted for more than 71 per cent of HH savings in FY23, the highest proportion in at least the past half-century (since 1970-71). HH NFS dropped to a four-decade low of 5.3 per cent of gross domestic product (GDP) in FY23. Given that residential real estate in India has significant forward and backward linkages with other economic sectors, and construction is the second-largest employment industry in India (after agriculture), this trend is not an immediate concern. In fact, this is pro-growth at the moment. However, if corporate investment starts rising, pushing the investment rate (as a percentage of GDP) higher, low NFS will be hard to ignore and likely to hamper a balanced surge in growth.

The writer is senior group vice-president, Motilal Oswal Financial Services