The worrying trend in household savings

With the share of physical assets rising, the responsibility to free up resources to fund corporate capex shifts to the government

Household sector savings play a critical role in financing corporate investment, as this is the only sector that is a net saver. Financial savings of households have assumed a special significance as the private corporate sector’s capital expenditure (capex), which had some false starts in the recent past, could now be expected to pick up, with the  uncertainty about the outcome of the general elections behind us, suggesting policy continuity. Other conditions continue to be conducive, such as healthy twin balance sheets (of companies and banks) and buoyant equity market. Additionally, the domestic interest rate cycle seems to have peaked and is likely to turn early next year, if not before. 

Household savings are held both in financial assets (such as bank deposits) and physical assets (mainly dwellings). Financial savings of households, after peaking at 18 per cent of gross domestic product (GDP) in 2006-07, declined to 10.7 per cent in 2011-12, and have since moved narrowly between 10 and 12 per cent (except during the pandemic year).

Households also have financial liabilities such as borrowings/loans from banks, non-banking finance companies (NBFCs) and  housing finance companies (HFCs). For financing investment by the corporate sector, what matters is net financial savings by households (savings in financial assets less financial liabilities), which, however, declined from 7.3 per cent of GDP in 2021-22 to 5.2 in 2022-23. This is the lowest rate in the last five decades, pulled down by a surge in financial liabilities from 3.8 per cent of GDP to 5.7 per cent.  An increase in financial liabilities of households not only reduces net financial savings directly, but also indirectly as a part of their future savings is used for debt servicing (payment of interest). 

Following the increase in financial liabilities, concerns were raised in media commentary about the rising indebtedness of households, with some even suggesting distress. These concerns, however, are misplaced as borne out by the following three points. First, based on the limited break-up that is readily available, at least 25 per cent of financial liabilities were for investment purposes (housing and education loans) during 2022-23. Of all financial liabilities outstanding at the end of March 2023, at least 29 per cent were in the form of investments (30 per cent at the end of March 2022). Second, financial assets of households were 2.7 times their liabilities at the end of March 2023 (2.9 times at the end of March 2022). Three, an analysis by the Reserve Bank of India (RBI) in December 2023 suggested that debt servicing burden (interest payments as a percentage of income) of Indian households declined from 6.9 per cent in March 2021 to 6.7 per cent in March 2023, one of the lowest in the world. Thus, the balance sheet of the household sector, despite a swell in financial liabilities, remains healthy. 

The real concern, however, is that a decline in their net financial savings, caused by a spurt in financial liabilities, can constrain corporate investments. What is worrying is that the financial liabilities of households are expected to have risen further in 2023-24. Personal loans from scheduled commercial banks (SCBs), which constitute about 40 per cent of the total financial liabilities of households, increased by 28 per cent in 2023-24 on top of an increase of 21 per cent in 2022-23. If loans by households from HFCs/NBFCs also increased at the same pace as from SCBs, then financial liabilities of households could have risen further in 2023-24. This could have further reduced net financial savings of households in 2023-24, unless offset by a reduction in their physical savings, which looks unlikely as detailed below.

Savings by households in physical assets are volatile and, in the past, tended to move largely in line with the residential real estate cycle. Savings in physical assets surged from 12.0 per cent of GDP in 2006-07 to peak at 16.7 per cent in 2011-12, when the real estate cycle also peaked. They, thereafter, declined to 11.2 per cent of GDP by 2020-21 as the real estate cycle troughed. Post-pandemic, savings in physical assets began to rise again in line with the recovery of the real estate sector. While a spurt in physical savings partly reflected some pent-up demand for housing, still a sharp rise in physical savings is surprising. During the last upswing in the real estate cycle, the share of physical savings (excluding gold) in gross savings of households peaked at 67 per cent in 2011-12, co-synchronous with the peak of the real estate cycle. This time, however, the share of physical savings in gross savings touched 70 per cent in 2022-23, when the recovery in the real estate cycle had just begun. Savings in physical assets could be expected to rise going forward, considering that real estate cycles are normally long, ranging from six to eight years. 

The savings rate of the private corporate sector (non-financial) improved in recent years to 10.1 per cent of GDP on an average during the last eight years ending 2022-23, compared with 8.8 per cent in the previous eight years.  However, even this improved savings rate will not be enough once the private investment cycle picks up.  Investments by the private corporate sector exceeded its savings by 4 percentage points of GDP in the previous capex cycle (2003-08). Apart from the usual business requirements, companies would also need to invest for climate action. 

The onus of supporting private investment thus squarely falls on the general government, which would require reduction in its dissaving.  During the previous capex cycle, the savings rate of the general government turned around by close to 4 percentage point of GDP from (-) 3.3 per cent of GDP in 2003-04 to 0.5 per cent of GDP at the peak of the capex cycle in 2007-08. These were the initial years after the Fiscal Responsibility and Budget Management Act, 2003, was enacted and tax buoyancy was high at 1.6 (on an average), reflecting the robust growth in nominal GDP. Finances of the general government, thereafter, have been marred by two exogenous shocks: (i) the global financial crisis in 2008; and (ii) the pandemic in 2020, though the general government has done well to reduce the gross fiscal deficit (GFD) from a peak of 13.1 per cent of GDP in 2020-21 to 8.6 per cent in 2023-24.

Beyond 2023-24, the GFD of the central government is budgeted to decline to 4.9 per cent of GDP in 2024-25 (from 5.6 per cent in 2023-24) and 4.5 per cent in 2025-26. The central government has committed to stay the course and reduce the fiscal deficit each year, thereby placing its debt-GDP ratio on a declining path. This should free up resources, which bodes well for financing corporate investment. Hopefully, once the private capex picks up, the tax-GDP ratio would improve, making the fiscal consolidation process less challenging.

The writer is senior fellow, Centre for Social and Economic Progress, New Delhi