It is now almost certain that India will see a small Current Account surplus in FY21, its first in 17 years. A sharp drop in oil prices and lower fuel consumption owing to limits on mobility is expected to push down the country’s net oil import bill sharply during the year. Besides, weak domestic consumption and investment demand would also aid in controlling imports.
Notwithstanding this intuitive explanation, it is interesting to view this current account surplus from a National Accounts identity perspective. As per the national savings-investment identity, current account balances are manifestations of the difference between a country’s investment and domestic savings rate. In other words, a country that runs a current account surplus is a net exporter of capital as its domestic savings are more than sufficient to meet its investment needs.
This would imply that India’s savings rate would exceed its investment rate in FY21, the first time after the FY02-04 period – when the country last saw current account surpluses. However, unlike in FY02-04, the surplus this time is expected to come about on account of a sharp fall in the investment rate and not an increase in the savings rate. In fact, the savings rate would also drop in FY21, just not as sharply as the investment rate.
This proposition becomes much clearer when one looks at the numbers. If the investment rate drops by ~4 percentage points to ~25.7% of GDP in FY21 and India witnesses a Current Account surplus of ~0.5% of GDP, this would imply an imputed savings rate of ~26.2% of GDP, 2.6 percentage points lower than ~28.8% in FY20.
Although correct, this is a perverse way of estimating the savings rate as it does not explain the reasons behind the fall. Just why would India’s savings rate fall in FY20?
There are two reasons. Firstly, the General Government is a dis-saver and has usually pulled down India’s savings rate. The general government fiscal deficit is expected to nearly double to ~12-13% of GDP in FY21 from ~6.3% in FY20, implying a very sharp increase in government dis-savings. Secondly, the corporate sector, which accounts for ~30% of domestic savings, is expected to see a fall in earnings in FY21. Nearly all industries are expected to see either a sharp decline in Profits After Tax or post losses during the year.
It is only reasonable to assume that the combined drag on the savings rate by the general government and the corporate sector is likely to be well above the 2.6percentage point drop in total savings rate that we estimated earlier. This would then imply that the household savings rate may actually increase in FY21.
This, however, is not intuitive; how can the household savings rate rise when a large number of people have lost their jobs and the employment scenario is expected to remain bleak throughout the year? There are some possible explanations.
Note, we reiterate that this is primarily arising from the Investment-Savings identity derivation. Moreover, the term ‘households’ includes individual households and non-corporate businesses too (unregistered micro, small and medium enterprises etc). The physical savings of households have weighed on household savings and the overall savings rate over the past decade meaning that investments (capital formation) by the household segment in real estate and housing has declined and may not move higher in the near term. So, household savings in financial assets, which have been falling (as a share of GDP) over the past decade, are likely to go up:
- Household savings are quite concentrated ie, bank deposits, which account for a large share of household financial assets, are skewed towards a few cities. While the Top 5 cities have ~3% of India's population, they have ~23% of India's total bank deposits owned by households and imply that they account for a large chunk of India’s aggregate savings. These households are likely to have a higher propensity to save given the income uncertainties due to COVID-19.
- The crisis may also spur an increase in precautionary savings especially by the low- and middle-income households as they reduced consumption to prepare for adverse scenarios. Besides, government transfers into accounts of the vulnerable sections are also expected to reflect in higher savings.
- In addition, the current crisis has also led to some forced savings due to the lockdown or the inability to spend as much on discretionary items, leisure and mobility due to restrictions. Consequently, consumption demand is expected to decline during FY21. Consider this – the consumption of petrol fell by ~36% YoY during the June 2020 quarter. This alone saved consumers as much as INR300bn during the period.
Household balance sheets have been deteriorating over the past decade as they have levered to support consumption and their savings rate has declined during this period. The COVID crisis may probably bring about a halt to this trend and lead to an increase in their savings rate and an improvement in the aggregate household balance sheet. However, it still remains to be seen whether this improvement is meaningful enough and also if it will endure in the medium term.
(with inputs from Rahul Agrawal, Economist, M&M)
(Sachchidanand Shukla is Chief Economist, M&M Group. Views are personal)
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