The Anatomy Of A Savings And Investment Slowdown

India’s investment slowdown has been relatively moderate in magnitude but long in duration.

A bronze bull statue stands at the entrance to the Bombay Stock Exchange building in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A bronze bull statue stands at the entrance to the Bombay Stock Exchange building in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

The Indian economy has been in the midst of a slowdown in both the investment and the savings rate. But reversing the investment slowdown, which is still underway, is more critical at this juncture due to the impact it has on the broader growth scenario. Those are two key takeaways from a chapter titled ‘Investment and Saving Slowdowns and Recoveries’ in the Economic Survey 2017-18 released on Monday.

The survey starts by explaining that while there has been a slowdown in the savings and investment rate, both remain above the levels that prevailed throughout the 1990s. Analysis of the longer-term trends suggests that the boom of the 2000s, where there was a 9 percentage point pick-up in domestic saving and investment rates, was exceptional.

During this period:

  • The ratio of gross fixed capital formation to GDP climbed from 26.5 percent in 2003, reached a peak of 35.6 percent in 2007, and then slid back to 26.4 percent in 2017.
  • The ratio of domestic saving to GDP rose from 29.2 percent in 2003 to a peak of 38.3 percent in 2007, before falling back to 29 percent in 2016.

A rebound to those levels, which would then take growth back to a range of 9-10 percent, cannot be taken for granted, said the survey while adding that neither savings nor investment is ‘unduly depressed’ at this stage.

What has driven the slowdown in investment and savings in India?

Five percentage points of the overall 6.3 percentage point fall in investment is on account of private investment, said the survey reiterating a narrative that has been well documented over the years. The fall in household savings has, in turn, been driven by a fall in physical savings, partly offset by an increase in the holding of financial assets, said the survey. Within financial savings, there has been a shift from currency and bank deposits towards market instruments, the survey added.

The current slowdown – in which both investment and saving have slumped – is the first in India’s history, the survey highlighted.
The Anatomy Of A Savings And Investment Slowdown

Savings vs Investment: Growth Consequences

Noting the simultaneous slowdown, the Economic Survey goes on to ask - should policies focus on boosting investment or savings? While both are crucial in the long run, the issue is about relative importance and urgency, says the survey.

It cites research conducted by economists Hausmann, Rodrik and Pritchett which showed that providing a simultaneous boost to both may not be necessary. Economic research suggests that successful economic performance is not necessarily explained by periods in which there is a rise in the savings rate.

In contrast, research shows that countries that experience growth transitions eventually see sustained higher rates of saving. Based on these findings, economists propose that policies should focus on encouraging investment, rather than saving, to boost growth.

For India, this means that policy priorities, over the short run, must focus on reviving investment, said the survey. Mobilising savings, through attempts to unearth black money or encouraging a shift away from gold investments, is important but perhaps not as urgent, said the survey.

The ‘animal spirits’ need to be conjured back, said the survey.

Recovery From An India-Type Investment Slowdown

The survey delves further into India’s investment slowdown and finds that it has been “relatively moderate in magnitude, long in duration, and started from a relatively high peak rate of 36 percent of GDP.” Also, it has been a balance sheet-related slowdown and unusually large compared to other such slowdowns, said the survey.

What do these characteristics portend for the extent of an eventual investment recovery? The survey notes that:

  • Investment declines flowing from balance sheet problems are much more difficult to reverse.
  • The median country reverses only about 25 percent of the decline 14 years after the peak, and about 40 percent of the decline 17 years after the peak.
  • If India conforms to this pattern, the investment-GDP ratio would improve by 2.5 percentage points in the short run.

The survey goes on to conclude that a urgent and clear policy focus on reviving investment is imperative. Some of this has already been undertaken via a step-up in public investment and attempts to resolve the twin balancesheet problem.

“These steps will have to be followed up, along with complementary measures: easing the costs of doing business further, and creating a clear, transparent, and stable tax and regulatory environment,” the survey said.

The focus of investment-incentivising policies has to be on the big and small alike. The ‘animal spirits’ need to be conjured back, it added.