Declining Household Savings Sparks Debate in India

Context:

The recent decline in household savings, driven by a significant reduction in net financial savings, has become a central topic of debate in India.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

1. Interpreting Lower Financial Savings
2. Implication of Higher Debt Burden
3. Macroeconomic Implications of Fall in Household Savings

Interpreting Lower Financial Savings

Net Financial Savings of Household:

• Defined as the difference between gross financial savings and borrowing.

Gross Financial Savings:

• Reflects the change in a household’s financial assets over a period.
• Includes bank deposits, currency, and investments in mutual funds, pension funds, etc.

Household Borrowing:

• Comprises credit from non-bank financial corporations, housing corporations, and mainly from commercial banks.

Factors Reducing Household Net Financial Savings:

• Increased Consumption Expenditure:
  • Households finance additional consumption by increasing borrowing or depleting gross financial savings.
  • The consumption to GDP ratio remained largely unchanged at 60.95% in 2021-22 and 60.93% in 2022-23, indicating this factor didn’t significantly reduce gross financial savings.
• Higher Physical Investment:
  • Households finance tangible investment by increasing borrowing or depleting gross financial savings.
  • The gross financial savings to GDP ratio decreased from 7.3% to 5.3% in 2022-23, while the household physical investment to GDP ratio rose from 12.6% to 12.9%.
• Increased Interest Payments:
  • Higher interest rates lead to an increase in interest payments by households.
  • Higher borrowing is partly offset by interest income from financial assets, but largely attributed to increased household interest payments.

Implication of Higher Debt Burden

Concerns for Macroeconomy:

1. Debt Repayment and Financial Fragility:
   • Household repayment capacity depends on income flow.
   • A key criterion for evaluating debt sustainability is the difference between the interest rate and income growth rate.
     • Interest payments to households are income for the financial sector.
     • Failure to meet debt repayment commitments reduces financial sector income and weakens their balance sheets.
     • This can negatively impact the macroeconomy if the financial sector reduces credit disbursement to the non-financial sector.
2. Effect on Consumption Demand:
   • Household consumption expenditure is influenced by disposable income, wealth, debt, and interest rate.
     • A reduction in household wealth can lead to decreased consumption as households try to maintain their wealth by increasing savings.

Macroeconomic Implications of Fall in Household Savings

Increasing Household Susceptibility:

• Both the stock indicator of debt to net worth and the flow indication of liabilities to disposable income are on the rise.

Impact of Higher Interest Rates:

• Higher interest rates, employed as a policy tool to control inflation by reducing macroeconomic output and employment, can escalate household debt levels.
• This can potentially lead households into a debt trap.

Effects on Consumption and Aggregate Demand:

• Elevated interest rates can negatively affect household consumption due to increased debt burden.
• This, in turn, can have adverse consequences for aggregate demand.

Changes in Household Balance Sheet Trends:

• Indicates a broader shift in the economy’s structure.
  • Financialisation of the Economy:
    • The asset side of the household balance sheet is transitioning from production-based assets to monetary or financial exchange-based assets.
    • This shift may render the goal of achieving a five trillion-dollar economy fragile and jobless.

-Source: The Hindu