Thursday, February 5, 2015

India's savings deficit

Can India emulate China's quarter century long episode of near double-digit growth rates? There are compelling reasons to the contrary, none more important than the following two graphics. The first graphic shows the steep differential between the two countries' gross domestic savings and gross fixed capital formation respectively.
China's spectacular growth story has been underwritten by the country's high savings rate, which rocketed beyond 50% of GDP in last decade. Its gross domestic savings rate today is almost twice as large as India's and its gross fixed capital formation is nearly twenty percentage points higher. Further, even as India's savings rate has been declining, that of China shows no signs of abating. Given the vastly different contexts, it appears unlikely for India to come anywhere close to the savings and investment rates achieved by China.

The second graphic shows how in case of India the fall in gross domestic savings and resultant decline in gross fixed capital formation coincided with the transition to the current lower growth trajectory. 
This clearly illustrates why a recovery to a higher GDP growth trajectory requires an increase in the country's savings rate from its 2013 low of 28% to its 2007 peak of 34% of GDP so as to support an investment rate in the mid-thirties. The sharp rise in savings in the 2003-08 period came on the back of a sharp rise in private corporate savings, which nearly doubled during the period. But given the debt-laden corporate balance sheets, a recovery of corporate savings to its peak rate of 8-9% of GDP appears unlikely in the foreseeable future.

Even the current savings rate figure is deceptive since the share of household savings being locked up in illiquid and unproductive investments like real estate and gold has grown in recent years. This shrinks the pool of investible savings available.

So here is the challenge. High growth rates cannot be sustained without high investment rates. But high investment rates in turn requires high domestic savings rate. The alternative of sourcing foreign capital runs the risk of assuming large current account deficits which leaves the country vulnerable to sudden-stops and capital flight. There are no easy answers. 

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