The fabric of India’s macroeconomic stability has been recently challenged by a notable reduction in household savings. The country has witnessed a substantial decrease in net financial savings, with the net financial savings to GDP ratio touching its most modest point in four decades. An examination of household savings trends delineates a contrast between physical savings, which include tangible assets and gold, and the dwindling net financial savings.
During the fiscal year 2022-23, despite a slight recovery in physical savings, there was a worrying plummet in household net financial savings. The net financial savings of a household represents the balance after subtracting borrowing from gross financial savings, the latter being the sum by which a household’s financial assets change during a period. These assets include bank deposits, currency, and investments in mutual funds and pension funds, among others. Predominantly, borrowing is sourced from commercial banks, with some contributions from non-bank financial corporations and housing companies.
Three primary factors contribute to a reduction in household net financial savings:
1. To fuel additional consumer spending, households either dip into their gross financial savings or amplify their borrowing levels. Extraordinary consumer spending for a given income can propel aggregate demand and economic output.
2. Households might also channel extra borrowing or diminish their gross financial savings to fund higher tangible investments, subsequently stimulating economic activity through the investment route.
3. An increase in a household’s interest payments, perhaps driven by higher interest rates, can compel a reduction in net financial savings either through expanded borrowing or by depleting financial savings.
In the fiscal year 2022-23, the first factor had a negligible role, as the consumption to GDP ratio remained relatively stable compared to the previous year. The second factor had only a marginal effect; the physical investment to GDP ratio increased slightly even as the gross financial savings to GDP ratio decreased significantly.
However, the rise in household debt, particularly due to increased interest obligations, is an underlying catalyst for higher borrowing. This dynamic is portrayed in the trends of household borrowing to income ratio, debt to income ratio, and the relationship between physical savings and gross financial savings.
The recent spike in household debt as a percentage of disposable income, coupled with a shift in household assets favoring financial assets, has ignited two substantial fears for India’s broader economy:
Firstly, the threat of financial fragility arises from households’ ability to manage debt repayment. The litmus test for debt sustainability is the gap between interest and income growth rates; if households fail to honor their debt commitments, the repercussions could be detrimental to the financial sector’s balance sheets and, by extension, the macroeconomy.
Secondly, there’s apprehension regarding consumption demand, which may be impacted by fluctuations in household wealth, debt levels, and interest rates. Any decline in household wealth could compel households to conserve their assets by boosting savings, potentially dampening consumption.
The acute threat is that higher household debt might precipitate credit rationing by banks or intensify the financial burden on families, thereby curtailing consumption and aggregate demand.
In a recent snapshot, the financial wealth or net worth of Indian households—calculated as the difference between financial assets and liabilities—has seen a precipitous fall. This decline in wealth, paired with an uptick in household leverage, has resulted in a distinct slowdown in the growth of private final consumption expenditure.
This scenario poses serious concerns for India’s economic growth and stability. The increasing vulnerability of households due to higher debt levels, the seeming ineffectiveness of higher interest rates to counteract inflation without incurring additional economic costs, and the resulting risks to consumption demand and aggregate demand are astounding.
Experts at Azim Premji University examining these patterns suggest a structural economic shift. A tilt towards financial asset acquisition suggests an emerging financialization of India’s economy. This movement from a production-centric to a finance-driven economy contends with the peril of fostering fragile economic conditions and lower job creation, at a time when India aspires to be a five-trillion-dollar economy.
