Savings-investment myth of demonetisation

Going by the numbers, there seems to be lots to cheer post-demonetisation. Indian households, who hitherto would have spent all their waking hours thinking of how to add to their holdings of property, gold and silver jewellery, have now adopted the mantra of ‘less cash’. So, as latest data reveals, Indian households’ holdings of cash have turned negative and they have started saving more in the form of bank deposits, life insurance funds, as also in shares and debentures post-demonetisation. This is good news indeed! For, it is such ‘financial savings’, which when made available to firms, facilitate growth-inducing investments in machinery, equipment, and factories.

So, are we in for some ‘acche din’, now that the saving-investment balance has been set right? Not quite. Time for some myth-busting!

Myth 1: Households save while firms invest.

Fact: Not quite. Households in India both save and invest. Individuals, Small and medium enterprises and non-profit institutions constituting the ‘household’ segment in India have been the drivers of both savings and investments in the recent past. In 2001-2002, households accounted for 94 per cent of India’s overall savings, and almost 50% of India’s investment. These shares have fallen by 35% and 10 % respectively to about 59% and 36% respectively. Yet, households continue to be the dominant savers as well as important investors, albeit trailing private firms closely in investments.

Myth 2: Indian firms are responsible for the current de-growth due to lower investments.

Fact: Contrary to popular perception, private sector savings as well as investments have actually increased, especially since 2001-02. It is the private corporate sector, which, surprise of all surprises, has filled in the gap vacated by households, particularly in savings. Thus, savings of the private sector increased from 13% in 2001-02 to about 36% in 2015-16. Similarly, private firms are driving India’s investments, by contributing to almost 40% of India’s overall investments. However, it is true that there exists a saving-investment gap in the private corporate sector, with private investments exceeding private savings. Such a gap is currently funded either by domestic household savings or external savings.

Myth 3: Financial savings by households are the most important for driving investments in the economy.

Fact: The non-attention to household physical savings and investment may be responsible for the current crisis in the construction and real estate sectors, and in the general economy. While financial savings of household matter, so do savings in physical assets. For it is such physical savings which drive household physical investments in dwellings, other buildings and structures, which in turn drive sectors such as construction and real estate both through their direct and indirect demand effects.

The construction sector, including real estate, is the second largest employment generator after agriculture in India. It has strong backward linkages with ancillary, as well as complementary industries such as cement, steel, iron, bricks, sand, chemicals, heavy machines and equipment, sanitary ware, wood, electrical and other fixtures, paints and others, as also services such as transportation services etc. An increase in investment and, hence, output in the construction sector has been estimated to have a 2.4 times positive impact on the overall output. A large part of the dip in India’s investments has been driven by this dip in household investment. This itself is explained by the dip in household savings in physical assets. Clearly, the dip in household physical investment is not what we would wish to see going forward.

Myth 4: Indian households have an insatiable appetite for holding cash.

Fact: The share of currency in overall household savings had actually reduced between 2011 to 2015. Spurred by the buoyant stock markets, household saved in the form of shares and debentures. However, so did they in the form of provident and pension funds, as also in small savings and savings in non-bank deposits. Preference for bank deposits had waned possibly on account of the lower real interest rates to be earned on deposits.

Myth 5: Demonetisation was required to reduce Indian households’ appetite for cash, and to transfer cash towards the financial sector, where it could be used productively.

Fact: The proportion of currency in overall household savings turning to negative as per latest data, as also the increase in household bank deposits in 2016-17 is clearly the effect of demonetisation. However, such trends are at best transitory. Interpreting these as success metrics of the demonetisation exercise is clearly delusional. Long-term behavioural changes in household savings preferences would be required for such trends to sustain.

The India growth story will depend critically on sifting facts from fiction. Has demonetisation really transferred cash from the pockets of people to the banking sector, on to firms for investment? The jury is still out on this one. It may be too early to pop the bubbly yet.

The writer is the Professor of Economics and Program Head, PGP-Family Managed Business at SPJIMR, Mumbai. Views are personal.

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